The PPT is essentially a “purpose”-driven inquiry seeking to ascertain the subjective reasons of an investor to locate in a favourable tax-treaty jurisdiction, and a handle to the revenue to deny the treaty benefit in the event such benefit constitutes “one of the principal purposes” of the multinational structure leading to such benefit.
The ministry of finance has sprung a pleasant surprise a week before the Budget. Obviating investors’ concerns about the entitlement of tax treaty benefits, the Central Board of Direct Taxes (CBDT) has issued a “guidance” to clarify the scope and application of the tax treaty anti-avoidance Principal Purpose Test (PPT). (Image/Freepik)
By Mukesh Butani and Tarun Jain
The ministry of finance has sprung a pleasant surprise a week before the Budget. Obviating investors’ concerns about the entitlement of tax treaty benefits, the Central Board of Direct Taxes (CBDT) has issued a “guidance” to clarify the scope and application of the tax treaty anti-avoidance Principal Purpose Test (PPT). Borne out of the global disenchantment against misuse of treaties — as a part of the OECD-led base erosion and profit shifting initiative (BEPS) — PPT standard forms part of the multilateral instrument (MLI) framework, which was ratified in 2019 and has been engrafted in Indian Double Taxation Avoidance Agreements (DTAAs). Arun Jaitley signed the MLI at the June 2019 OECD Paris ceremony.
The PPT is essentially a “purpose”-driven inquiry seeking to ascertain the subjective reasons of an investor to locate in a favourable tax-treaty jurisdiction, and a handle to the revenue to deny the treaty benefit in the event such benefit constitutes “one of the principal purposes” of the multinational structure leading to such benefit. Put differently, the PPT compels multinationals to rely on business reasons or commercial considerations uninfluenced by tax-benefit considerations. It is positioned alongside the general anti-avoidance rule (GAAR), which similarly operates to deny tax benefit to structures lacking “commercial substance”.
Both the PPT and GAAR can legally override tax residency certificates, which, as per the law laid down by the Supreme Court in the Azadi Bachao Andolan case, has served for the past two decades as a substantive limitation on the revenue’s ability to question the propriety of corporate structures. Hence, introducing the PPT standard in the tax treaty space shakes the very foundation of MNC decisions on the choice of investment jurisdictions. Therefore, the CBDT guidance entails how tax officers will apply the PPT and is timely. Though there haven’t been material disputes in this area, concerns among multinationals, particularly foreign portfolio investors and those operating in the GIFT City, prevailed. Equally, multinationals with regional headquarters located in specified European and Asia-Pacific regions have been denied treaty benefits. So a perceived risk of denial of treaty benefits has been an essential business-risk imperative.
To amplify positive takeaways, the guidance clarifies that the denial of treaty benefit isn’t a matter of subjective satisfaction of the revenue — limiting revenue’s discretion. Instead, invocation of PPT must be based on “objective assessment of relevant facts”. Given that India legislated GAAR in 2017, investors feared retrospective application of PPT standards. Nipping them in the bud, the guidance, besides clarifying the PPT’s prospective application, sets out specific illustrations on the date of application.
The guidance further posits with respect to key foreign direct investment destinations, namely Cyprus, Mauritius, and Singapore, to clarify that the PPT cannot overcome grandfathering provisions under these treaties. To this end, the guidance reaffirms the importance of bilateral protocols between India and its counterparts. This reassurance obviates the scope of forever-ambitious interpretation by tax officers, which, though often overridden by judicial proceedings, upend years of efforts to address investor anxieties. The bilateral negotiations leading to protocols with these countries led to a stable transition in addressing India’s concerns on capital gains taxation and purposeful institutional investment jurisdictions.
To address other eventualities, the guidance has connected the PPT to India’s official position at multilateral forums, such as BEPS and the United Nations. The reference to positions expressed by India in the UN multilateral forum is puzzling, though, given that the OECD architected PPT standards.
It is now judicially settled that instructions of the CBDT draw upon its statutory empowerment binding upon tax officers, and create an enforceable legal right for taxpayers. The guidance is, therefore, a proactive measure to promote tax certainty and quell interpretative disputes. It is, at best, illustrative of the government’s commitment to rein in unnecessary tax controversies.