In a relief to foreign portfolio investors and asset managers, the Central Board of Direct Taxes (CBDT) has clarified its stand on the Principal Purpose Test (PPT) in relation to Double Taxation Avoidance Agreements (DTAAs). The Board has said that this will be applicable from a later date which will allow grandfathering on previous investments. Last year, PPT was implemented by amending the India-Mauritius tax treaty to prevent taxpayers from misusing the treaty.
However, it has left room for interpretation as to whether it will apply for tax purposes to investments made before April 2017 or whether it will be applicable from a later date. Clarification on PPT has been given in CBDT’s circular dated January 21. India has certain bilateral commitments with Cyprus, Mauritius and Singapore in the form of grandfathering provisions.
The CBDT circular said that these commitments are not linked to the PPT provisions. It is, therefore, clarified that the provision of grandfathering under such DTAAs will continue to remain outside the scope of the PPT provisions. Instead, it will be governed by the specific provisions of the relevant DTAA.
Under the PPT, taxpayers can avail of the benefits of the agreement only if they can establish that the benefits are in accordance with the relevant provisions, including substance requirements (certain rules and evidence). Substance includes employees, offices, turnover, expenses, etc. for operations in a specific country.
The PPT was an important element since the entry into force of the multilateral treaty for the implementation of tax treaty related provisions to prevent base erosion and profit shifting (MLI). In India, MLI came into force in October 2019.
Rohinton Sidhwa, partner, Deloitte India, said the circular establishes the primacy of the grandfathering clause that is included in some treaties (Cyprus, Mauritius and Singapore). Essentially this circular protects the specific bilateral commitments of such a treaty and places them outside the provisions of the PPT. This was an undefined area when the new protocol to the India-Mauritius treaty was made public. However, the PPT provisions have not been notified yet. But Sidhwa is of the opinion that with this clarification the protocol can be notified and made effective in the coming financial year. Singapore and Mauritius are among the top five countries in terms of Assets Under Custody (AUC) of FPIs in India.
The total AUC for Singapore (which is second in the list) stood at Rs 7.29 lakh crore in December 2024, while for Mauritius it was around Rs 3.76 lakh crore. Mauritius is now the fifth country in India in terms of highest AUC.