The global tax landscape is constantly evolving to keep pace with ever-changing business models and structures. Introduction of the Base Erosion and Profit Shifting (BEPS) project by OECD/G-20 in the year 2016 was one such significant international step since the advent of bilateral tax treaties, wherein more than 100 countries collaborated to block tax avoidance strategies that exploit gaps and mismatches in tax rules across jurisdictions. The Multilateral Instrument (the MLI), an outcome of BEPS Action Plan 15, allows governments to amend various tax treaties without the need to individually re-negotiate each treaty bilaterally. This has resulted in obviating the complex procedures involved in re-negotiating treaties and providing a quick solution to implement BEPS measures.The MLI will not replace the existing treaties completely; instead, it will either modify, supersede, supplement or complement their application to bring them in line with the measures to address base erosion.With effect from 1 April 2020, its impacts will be seen in India’s treaties with countries such as Singapore, France, Netherlands, United Kingdom etc., for which the MLI is in effect.

While deliberation on the MLI to implement tax treaty related measures to prevent BEPS was ongoing, the Indian government implemented General Anti Avoidance Rules (GAAR) under the domestic law from 1 April 2017 in an attempt to curb tax avoidance/tax evasion arrangements.

In 2019, the MLI came into force for India, and its provisions have come into effect from 1 April 2020 for the covered nations. Under the MLI, Principal Purpose Test (PPT) is a minimum standard for the treaty, providing that the treaty benefits will be denied if it can be reasonably concluded that obtaining such benefit was one of the principal purposes of an arrangement. In other words, PPT is a non-obstante provision with a mandate of denial of treaty benefit to all arrangements or transaction, if not satisfied. PPT will significantly modify the application of the treaty and will go a long way in countering treaty abuse.

The moot question that arises with the onset of PPT is whether PPT can co-exist with the GAAR provisions or whether one will supersede the other.

Domestic tax laws play a crucial role in determining the nature and taxation of a particular income. A reference to a bilateral tax treaty is made only once the taxation rights in the respective jurisdiction has been established. GAAR provisions are part of the domestic Income-tax laws, and hence, need-based invocation of GAAR provisions for a transaction is easier.

Once reference has been made to a tax treaty, the provisions of the treaty are binding on the parties to the arrangement. PPT, being the minimum standard adopted, should also have a binding effect and it can thus be said that PPT is imperatively linked to availing benefit under the tax treaty.

Based on the object of both provisions and considering the above, it could be said that GAAR and PPT should complement each other, thereby co-existing rather than one superseding the other. Revenue authority’s arsenal, to combat tax avoidance, would therefore include domestic anti-avoidance provisions i.e. GAAR as well as the PPT, where benefit under a treaty is availed.

While the two anti-avoidance provisions would complement each other, there are significant distinctions between the two, inter alia, in relation to their applicability, reach, consequences etc., which have been discussed briefly as follows:

Domestic v/s cross border arrangements: GAAR, being a provision under the domestic law, willhave applicability for both domestic as well as cross-border transactions while PPT would be applicable only in case of cross-border transactions where benefit under the tax treaty is availed.

Scope of GAAR and PPT: GAAR is applicable only if the “main purpose” of an arrangement is tax benefit, and one of the tainted element tests is satisfied while PPT is applicable if “one of the principal purpose” of an arrangement is tax benefit under the tax treaty. Though PPT appears to offer a broader net to catch transactions that fall through the cracks of GAAR, both require an objective analysis of all the facts of an arrangement.

Consequences of application of GAAR and PPT: GAAR appears to have a wider reach, as the Revenue Authorities can re-characterise, reclassify, combine or disregard a transaction, reattribute income in the hands of a third person or deny benefit under the treaty. On the other hand, PPT’s scope is restricted to denial of treaty benefitsin a particular arrangement.

Threshold: GAAR provisions do not apply to an arrangement where the tax benefit arising to all the parties in the relevant tax year does not exceed INR 3 crores. No such threshold is provided for the application of PPT.

Grandfathering: While certain specified transactions entered prior to 1 April 2017 are excluded from the applicability of GAAR provisions, PPT has no such carve out even where the structure has been in place for years together, or an existing structure is acquired in a transaction. For e.g.,for a person resident in Singapore, income from investment prior to 1 April 2017 is grandfathered from GAAR provisions; however, PPT shall be applicable for any benefit claimed under the Indian Singapore Treaty from 1 April 2020.

PPT along with GAAR is expected to revolutionise the manner in which the arrangements or transactions are looked at by the tax authorities.Least to say, the MLI has arrived on the global tax platform and will change the manner in which benefits under the tax treaties are availed. Going forward, businesses will have to re-evaluate the existing structures and align with the international best practices driven by substance over form.


Author: Mayur Desai – Executive Director, Deals, PwC India and Jinal Mehta – Associate Director, Deals, PwC India.


(The views expressed in this article are personal. The article includes inputs from Parag Doshi – Executive Director, Deals, PwC India and Bhakti Sharma – Associate, Deals, PwC India.)

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June 2021