1. Introduction to the ‘Limitation of Benefit’ Clause in Double Taxation Avoidance Agreement (DTAA):

Double Taxation Avoidance Agreements (DTAAs) were developed to address the problem that arose due to international double taxation. Double taxation occurs when a certain income is taxed in two different countries resulting in the income being taxed twice. These situations generally arise at international level when various countries make a claim to tax the same sum of income. The most common reason for such a situation to arise in an international transaction is due to the coinciding of a specific country’s claim to tax the income based on the principle of territoriality with the other country’s right to tax the same income based on the resident rule[1]. This results in a situation where the taxpayer is required to pay tax on the same income twice due to a clash between the national laws that exists in different countries.

DTAAs are formulated with the objective of preventing double taxation. These tax treaties are beneficial to the taxpayers as they intend to reduce the tax burden that would have existed without these treaties being in place. But, along with proving advantageous to the taxpayers, these treaties have also provided scope to abuse the existing international tax regime. Individuals and corporations who are not entitled to the benefits under such tax treaties have been observed taking advantages of the treaty arrangements that exists between other countries.

DTAA Double taxation avoidance agreement and blue pen.

These individuals belonging to the non-treaty country take advantages of such DTAAs by forming a business entity in the country in which the treaty exists for being eligible to take advantage of the tax arrangement that exists in the country and then channel the gain that was made under the treaty back to the country which is not a part of the treaty. The sole purpose of setting up a business entity in the treaty country is to funnel profits from that country to the non-treaty country. This act performed by the individuals and corporations of non-treaty country is called “treaty shopping”[2].

It was imperative to prevent treaty shopping that was being practiced at a large scale by various individuals and corporations as a tool for evading tax liability. With an objective to prevent treaty shopping, a clause was introduced in the treaty that would restrict the benefits derived under the treaty to be availed only be limited number of individuals and entities based on the proximity with the treaty country. This clause in the treaties came to be known as the ‘Limitation of Benefit’ clause[3]. The purpose of this clause was to exclude conduits and shell entities from availing the benefits under the treaty arrangement by recognizing considerable business nexus between the company and the country in which the treaty operates.

II. Indian Model of ‘Limitation of Benefit’ clause in the Double Taxation Avoidance Agreement:

This section of the article will discuss in detail the framework of the ‘Limitation of Benefit’ clause that exists in various DTAAs in India. This section will begin with laying an overview about the various DTAAs that exist in India along with focusing on the provision of the Income Tax Act, 1963 which empowers the Central government to enter in these DTAAs with different nations. The second part of this section will delve into one specific DTAA which is the India-Mauritius treaty. While discussing this treaty, various Supreme Court judgments will be discussed to lay down the manner in which ‘treaty shopping’ was considered permissible by the courts. This discussion will finally lead to mapping out the manner in which the ‘Limitation of Benefit’ clause was introduced in the Indian tax regime through the Supreme Court of India in the case of Azadi Bachao Andolan v Union of India[4].

a. Overview of the DTAAs and the Income Tax Act, 1996 in India:

The Indian government has entered into almost 90 DTAAs with various countries along with entering into treaty arrangement with various territories such as Cayman Islands, Bermuda, Macau etc. The government has been empowered to enter into treaty agreement with other countries through the virtue of Section 90 of the Income-tax Act, 1961. This provision grants the government the power to allow various relief on the income which has been taxed twice due to double taxation and also the authority to avoid double taxation of income.

Section 90(2) of the Act further states that in situations where both the Income Tax provision and the DTAA is applicable to the assesses in regarding the avoidance of double taxation then whichever arrangement is more advantageous to the assesses would apply in that situation. Therefore, reading section 90 of the Income Tax Act, 1963 in its entirety shows that the Central government has not only been authorized to enter into treaties with a foreign government to avoid double taxation but also provides a mechanism through which the DTAAs have to be implemented between India and the other countries.

b. The India-Mauritius Treaty and the emergence of the ‘Limitation of Benefit’ clause in the Indian regime:

The reason for focusing on the Indian-Mauritius treaty is based on the large amount of controversy that arose due to it over the years. The reason behind these controversies were the various aspects of this treaty which allowed double non-taxation along with providing scope for treaty shopping[5]. The double non-taxation was possible in this treaty as it required the capital gains to be taxed only in the country were the assesses resided and not based on the source rule of taxation. This also applied to the capital gains that were received on the sale of the of shares of a company.

The application of this arrangement meant that the capital gains which arose from the sale of the shares of an Indian company, would be taxable in the jurisdiction were the assesses resided, which was Mauritius under this treaty. Now, Mauritius being a low-tax jurisdiction, does not have any requirement for the capital gain to be taxed. This provided scope for the residents of Mauritius to take advantage of being exempted for paying any tax in the Indian jurisdiction for the capital gain that arose out of the transaction along with not being required to pay any tax on this transaction in Mauritius. This treaty was being used to avail this double non-taxation benefit by the residents of Mauritius.

This treaty was also being used for ‘treaty shopping’ which had led to a huge controversy. ‘Treaty shopping’ was being performed by those investors who were planning to invest in India. These investors with an objective to avail the benefit that existed under this treaty became residents in the jurisdiction of Mauritius. They set up shell companies only with the objective of getting an advantage under this treaty and used them to channel the profits that was made through these companies to the non-treaty nations, were these investors resided. This became a serious issues and various controversies arose due to the existence of this arrangement. The Central Government of India tried resolving these controversies by circulating a notification stating that ‘treaty shopping’ was permissible[6]. This notification just required a proof of residence which the assesses had to obtain from the Mauritian tax authorities in the form of a Tax Residency Certificate[7].

This notification by the Central government was challenged in the Supreme Court of India in the case of Azadi Bachao Andolan v. Union of India[8]. The court held the validity of these circulars and observed that treaty shopping was permissible under the arrangement which existed between India and Mauritius. It went on state that if the Indian Executive wanted to prevent any treaty shopping to take place under this DTAA, then it was essential for them to adopt a ‘Limitation of Benefit’ clause[9]. The insertion of this clause in the treaty would basically restrict the benefit that could be availed under the treaty. Since, the treaty did not have a ‘Limitation of Benefit’ clause there was not an express or implied restriction to prevent people from non-treaty countries to claim benefit under this treaty. Therefore, after this decision by the Supreme Court of India, the Indian and the Mauritian government negotiated to insert a ‘Limitation of Benefit’ clause on 1st April 2017 to the DTAA that existed between both these countries.

The ‘Limitation of Benefit’ clause that was inserted in the India-Mauritius DTAA:


“1. A resident of a Contracting State shall not be entitled to the benefits of Article 13(3B) of this Convention if its affairs were arranged with the primary purpose to take advantage of the benefits in Article 13(3B) of this Convention.

2. A shell/conduit company that claims it is a resident of a Contracting State shall not be entitled to the benefits of Article 13(3B) of this Convention. A shell/conduit company is any legal entity falling within the definition of resident with negligible or nil business operations or with no real and continuous business activities carried out in that Contracting State.

3. A resident of a Contracting State is deemed to be a shell/conduit company if its expenditure on operations in that Contracting State is less than Mauritian Rs. 1,500,000 or Indian Rs. 2,700,000 in the respective Contracting State as the case may be, in the immediately preceding period of 12 months from the date the gains arise.

4. A resident of a Contracting State is deemed not to be a shell/conduit company if:

(a) it is listed on a recognized stock exchange of the Contracting State; or

(b) its expenditure on operations in that Contracting State is equal to or more than Mauritian Rs.1,500,000 or Indian Rs.2,700,000 in the respective Contracting State as the case may be, in the immediately preceding period of 12 months from the date the gains arise.”

By the insertion of this clause, the benefit that was available under this treaty was denied to the resident of Mauritius or a shell entity which was set up with the sole objective of taking tax benefits that were being provided by the DTAA. The sub-clause (3) of the clause sets out criteria for declaring an entity as a shell company. It stated that a Mauritian company would be deemed as a shell company if its expenditure on its annual operation is less than Mauritian Rs 1,500,000 or Indian Rs. 2,700,000 in the immediately preceding year. And, subclause (4) lists out various criteria based on which a company could claim that they cannot be regarded as shell companies.

The result of the Azadi Bachao Andolan[10] case led to the introduction of ‘Limitation of Benefit’ clause in the DTAAs that India had with various countries. The countries like the United Kingdom, Singapore, United States ended up renegotiating the DTAA that existed between India and these countries to include the ‘Limitation of Benefit’ clause[11].

III. Analyzing the ‘Limitation of Benefit’ clause that exists in the DTAA between India and other countries:

a. India – United Kingdom DTAA:

The Indian government and the government of United Kingdom signed a protocol on 26th October, 2013 to amend the DTAA to include a ‘Limitation of Benefit’ clause in it to prevent any form of treaty shopping.

Article 28C – LIMITATION OF BENEFITS, reads as under[12]:

“1. Benefits of this Convention shall not be available to a resident of a Contracting State, or with respect to any transaction undertaken by such a resident, if the main purpose or one of the main purposes of the creation or existence of such a resident or of the transaction undertaken by him, was to obtain benefits under this Convention.

2. Whereby reason of this Article a resident of a Contracting State is denied the benefits of this Convention in the other Contracting State, the competent authority of that other Contracting State shall notify the competent authority of the first-mentioned Contracting State.”

This clause indicates that the benefits available under this treaty will not be made accessible to any resident of both the countries if the sole objective behind formulating the entity or perform any transaction was merely done to gain benefits that are available under the treaty. But, this clause also provides a safeguard to the assesses from being treated in a prejudicial manner by the authorities by expanding the clause to include sub-clause (2), which states that if a resident from either India or United Kingdom is denied the benefits under this treaty, then the tax authorities of the state were the income is being generated is required to inform the competent tax authorities of the country of the resident that they have been denied the benefit under this treaty.

b. India- United States DTAA:

The DTAA that exists between India and United States is different from the treaties that India has formed with other countries. This treaty is has been formulated based on the structure of the Model United Nations Convention. A protocol was further signed between India and United States to prevent any treaty shopping under the treaty. The ‘Limitation of Benefit’ clause that was inserted has set out different tests that are to be satisfied before claiming any benefit under this treaty. Generally, the tax that is deductible based on the source rule under the United States is to be deducted at a rate of 30% on the transaction. The ‘Limitation of Benefit’ clause inserted in this treaty has been stated below.

ARTICLE 24 – LIMITATION OF BENEFITS, reads as follows[13]:

1. A person (other than an individual) which is a resident of a Contracting State and derives income from the other Contracting State shall be entitled under this Convention to relief from taxation in that other Contracting State only if:

(a) more than 50 percent of the beneficial interest in such person (or in the case of a company, more than 50 percent of the number of shares of each class of the company’s shares) is owned, directly or indirectly, by one or more individual residents of one of the Contracting States, one of the Contracting States or its political sub-divisions or local authorities, or other individuals subject to tax in either Contracting State on their worldwide incomes, or citizens of the United States; and

(b)the income of such person is not used in substantial part, directly or indirectly, to meet liabilities (including liabilities for interest or royalties) to persons who are not resident of one of the Contracting States, one of the Contracting States or its political sub-divisions or local authorities, or citizens of the United States.

2. The provisions of paragraph 1 shall not apply if the income derived from the other Contracting State is derived in connection with, or is incidental to, the active conduct by such person of a trade or business in the first-mentioned State (other than the business of making or managing investments, unless these activities are banking or insurance activities carried on by a bank or insurance company).

3. The provisions of paragraph 1 shall not apply if the person deriving the income is a company which is a resident of a Contracting State in whose principal class of shares there is substantial and regular trading on a recognized stock exchange. For purposes of the preceding sentence, the term “recognized stock exchange” means:

(a) in the case of United States, the NASDAQ System owned by the National Association of Securities Dealers, Inc. and any stock exchange registered with the Securities and Exchange Commission as a national securities exchange for purposes of the Securities Act of 1934 ;

(b) in the case of India, any stock exchange which is recognized by the Central Government under the Securities Contracts Regulation Act, 1956; and

(c) any other stock exchange agreed upon by the competent authorities of the Contracting States.

After a careful examination of the clause, that exists in the DTAA between India and United States it can be said that there are three tests which have been laid down under this clause to satisfy the requirement for availing benefit under this treaty. These test have been discussed in detail below.

Test (a) : Ownership- Base erosion test:

The clause states that it is required for the resident of the contracting state is required to hold a minimum of 50% of shares in the company which is held by the resident in which the country of the residence of the company or by the citizen of United States. Along with this, it is required that more than 50% of the income generated from the company should not be given out to the residents of the non-treaty country.

Test(b): Active trade test:

The active trade test is related based on the engagement and the connection of the business activities of the corporation which is trying to avail the benefit under this DTAA. The first requirement for a company, which is a resident of the treaty state, is that it must be engaged in conducting active trade in the residence country. Secondly, the trade activities which are being conducted by the company must be somewhat in relation to the business of the payer in the other country. Thirdly, the income which is receive must be in relation to the business activity.

Test(c) : Stock Exchange Test:

It is required for the business entity to either be a resident in India or the United States. Also, it is required that the shares of the company are traded on a regular basis in the authorized stock exchange of the country.

IV. Contrasting the model of the ‘Limitation of Benefit’ clause in India with other countries”

This part of the essay will include a detailed discussion on the model of the ‘Limitation of Benefit’ clause that exists in five different countries. After all the models have been discussed, a comparison would be provided between the Indian model of the ‘Limitation of Benefit’ clause and the models that exist in the countries discussed below.

a. U.S. Model:

The first U.S. ‘Limitation of Benefit’ clause was formulated based on the U.S.-U.K tax treaty which was formulated in 1945. This treaty had a provision stating that there would exist a general 15% tax and 5% special withholding tax to be imposed on dividends. The requirement to qualify for the special tax benefit the assesses would be required to show that he meets the criteria set out under the ownership test as well as the active business test. But, along with this, they had a further condition stating that even if any assesses qualified under these two test, they won’t be able to get the special 5% reduction if it is proven that the relationship between the contracting companies in both the jurisdictions was formed only with the objective of securing a benefit under the arrangement of the DTAA. The objective behind such a strict requirement for benefiting from the withholding tax was to make sure that only genuine companies get a benefit under it[14].

Since, this first ‘Limitation of Benefit’ clause which included almost all modern limitations and was considered as a highly innovative clause was introduced in the U.S.- Germany tax treaty. Under this clause, there were three alternative methods through which an individual or entity could qualify for tax benefits[15]. The first test was the “automatic qualification” test. It listed down five classes which included various individuals, the government of both the countries, public listed companies, non-profit entities, and individuals fulfilling the requirement of the ownership test along with the base erosion test, automatically qualified for the treaty benefits. The second option was the “Active Business Connection Test”. To qualify under this, test the individual or the entity needs to have an active engagement with the trade and commerce of the other nation along with the requirement of the income being generated must be received only for the trade activities that are conducted. The last alternative is a provision of a safety valve, this allows the countries to the treaty to allow treaty benefits to an individual or an entity based on their discretion.

Then there have been various changes and amendments brought to the US Model treaty in 2016 to include various elements to the ‘Limitation of Benefit’ clause to include stricter conditions.

b. U.K.Model:

The U.K. model revolves around the concept of the “main-purpose test” as a means to prevent any form of treaty abuse[16]. Treaty shopping has been present in the U.K. international and domestic law for a long period of time. The ‘Limitation of Benefit’ clauses in the U.K. DTAA mostly focus on the motive of the taxpayer behind performing the financial transactions based on which they are trying to seek a tax benefit under the treaty. The main objective behind this test was to attack the capital gain avoidance schemes that were formulated by entities or individuals through the means of the reorganization of corporations with the sole objective of taking benefit under the treaty. There was also a requirement to prove that there was a bona fide objective behind the commercial transaction that was taking place between the individuals and the entities.

The standard for the determination of the main purpose of any commercial transaction depended upon the size of the tax advantage which was being granted in relation to the specific transaction. The question to be looked into was whether the tax benefit was the main objective for performing the transaction or if it was just an incidental to the commercial transaction that was taking place.

c. Australian Model:

Australia has eight tax treaties that have the ‘Limitation of Relief’ clause included in them. These clauses have been inserted with the objective to place a limitation on the percentage of the tax benefit that would be granted in the source country to the amount of income that has already been paid in the country in which the resident resides[17]. The main objective of this clause is to prevent double non-taxation through the method of connecting the tax benefit that is received based on the treaty in one country to the tax treatment that is performed in the other state. The ‘Limitation of Benefit’ clause has only been included by Australia in their treaty with Japan and the Unites States[18]. The ‘Limitation of Benefit’ clause with the US has been formulated based on the 1996 U.S. Model treaty with only minor changes to the clause. While the clause in the DTAA with Japan is a little unique. It contains four kinds of anti-abuse measures in it. These include a U.S. based ‘Limitation of Benefit’ clause, a subject-to-tax clause, then the resident is also required to pass the “main-purpose test “and there also exists an anti-treaty shopping rule in the DTAA.

Australian tax treaties also contain certain specific anti-double taxation rules in them. These are extremely specific and are formulated with the objective of the target of focusing on preferential tax treatment to specific kinds of industries, specific entities, and specific kinds of transactions. The Australian DTAA has specific anti-abuse measures intertwined with each other.


The ‘Limitation of Benefit’ clause in a DTAA varies based on the tax regime of every country. The DTAA which has been formed by India The DTAA which are formed by countries like the United Kingdom, India, Mauritius, Singapore place their central focus on the purpose behind the formation of the resident entity and the objective behind conducting the transaction. And, the entities and the transactions which are formed with the sole objective of taking benefit under the DTAA are denied making any claim for tax benefit under the DTAA. On the other hand, the DTAA which has been formulated with the Unites States is a lot more focused on nature and the characteristic of the entities and the individuals who are seeking tax benefit under the treaty.


[1] Aarati Krishnan, ‘All You Wanted to Know About: Tax Terrorism’, BUSINESS LINE October 13, 2014, < https://www.thehindubusinessline.com/opinion/columns/All-you-wanted-to-know-about-Tax-terrorism/article20885792.ece>(Last visited on 11THNovember, 2019)

[2] Andrew Mitchel, ‘Treaty Shopping and Anti-Treaty Shopping’, International Tax Blog May 18, 2008, <https://intltax.typepad.com/intltax_blog/2008/05/treaty-shopping.html> (Last visited on 11th November, 2019).

[3] ‘How to Get Relief in case of Double Taxation’, TAXGURU August 1, 2012, < https://taxguru.in/income-tax/relief-case-double-taxation.html >(Last visited on August 25, 2016).

[4] (2004) 10 SCC 1.

[5] ‘Here are the Various Facets of Mauritius tax treaty’, THE ECONOMIC TIMES May 16, 2016, <https://economictimes.indiatimes.com/news/economy/policy/here-are-the-various-facets-of-mauritius-tax-treaty/articleshow/52285795.cms?from=mdr> (Last visited on November 11, 2019).

[6] Central Board of Direct Taxes, Circular No. 682/1994 (March 30, 1994).

[7] Id.

[8] (2004) 10 SCC 1.

[9] Id.

[10] Supra n.8.

[11] Punit Shah, ‘Tackling treaty-shopping’, FINANCIAL EXPRESS February 21, 2014 <https://www.financialexpress.com/archive/tackling-treaty-shopping/1227824/> (Last visited on November 12, 2019).

[12] U.K. – India tax treaty, signed on 26th October, 2013.

[13] U.S. – India tax treaty, signed on 12th September, 1989.

[14]Double Tax Treaty with the United States of America, Deloitte 14th October, 2016, <https://www2.deloitte.com/content/dam/Deloitte/ie/Documents/Tax/US%20treaty%20consultation%20response%2014102016%20.pdf> (Last visited on November 13, 2019).

[15] Dietmar Anders, The Limitation on Benefit Clause of the U.S.-German Tax Treaty and its Compatibility with European Union Law, 18 Nw. J. Int’L. & Bus. 165 (1997-1998).

[16] Limitation on Benefits Clauses: The Balancing Act Between Business Needs and Tax, Alvarez and Marshal 30th May, 2013 https://www.alvarezandmarsal.com/insights/limitation-benefits-clauses-balancing-act-between-business-needs-and-tax (Last visited on November 14, 2019).

[17] New tax treaty with Germany: a model for Australia’s future tax treaties, Taxtalks 25th October 2016, < https://www.pwc.com.au/tax/taxtalk/assets/monthly/pdf/new-german-treaty-nov16.pdf> (Last visited on November 15th, 2019).

[18] Michael Rigby, ‘The protocol to the Australia- United States tax treaty’, Allens 2003, < https://data.allens.com.au/pubs/pdf/tax/taxtreaty2.pdf> (Last visited on November 15th, 2019).


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