Principal Purpose Test unveiled: India sheds light on PPT’s application under DTAA

Following the release of the protocol between India and Mauritius with a view to introduce the principal purpose test (“PPT”) in the double taxation agreement (“DTAA”) between the two countries in March 2024, stakeholders were actively seeking any guidance on the application of the protocol, in particular as regards the impact of the PPT on grandfathered transactions.

In a communiqué dated 21 January 2025, the Central Board of Direct Taxes of the Government of India put an end to this wait.

The PPT is a key component of the BEPS minimum standards in the fight against base erosion and profit shifting and to combat any revenue leakage through treaty abuse.

Under the PPT, after considering all relevant facts and circumstances (assessed objectively), if it is reasonable to conclude that one of the principal purposes of any arrangement or transaction was a direct or indirect benefit, the said resulting benefit shall be denied, unless it is in accordance with the object and purpose of the convention/agreement.

Once the protocol enters into force, the PPT provision under India's DTAAs is to be applied prospectively.

For the Mauritius IFC, what was most awaited was clarity regarding the implications of the PPT provision on Treaty-specific bilateral commitments. The India-Mauritius DTAA includes certain treaty-specific bilateral commitments through grandfathering provisions. The communiqué clarified that those provisions are to remain beyond the ambit of the PPT provision. The grandfathering provisions will therefore continue to be governed instead by the specific provisions of the DTAA itself.

What this means for investors

Investors are expected to draw comfort from the clarifications brought by the guidelines.

This means that the grandfathering of the capital gains exemption in relation to investments made prior 1 April 2017 will continue to apply.

However, as regards non grandfathered investments, the PPT would apply if a benefit under the treaty is claimed after the entry into force of the provision.