The Union government has clarified that grandfathered investments under the India-Mauritius, India-Singapore and India-Cyprus Double Taxation Avoidance Agreements would not be subject to greater scrutiny under the principal purpose test.
The government's clarification aims to end the ambiguity over whether past investments will be covered under the amended protocol that includes the PPT clause. With this, the tax authorities will not move against past investments that have been grandfathered.
The clarification will help the tax authorities in ensuring that they do not start litigating issues like whether the PPT applies to grandfathered treaty provisions. It is a win-win scenario for tax authorities and taxpayers, according to Dhruv Janssen-Sanghavi, founder of Janssen-Sanghavi & Associates.
Under the PPT clause, tax authorities can deny treaty benefits if they come to a conclusion that one of the main purposes of relying on a tax treaty is to obtain a tax benefit. The government has clearly stated that the PPT clause will have a prospective application to ensure uniformity across India's DTAAs.
"Taxpayers whose investments from Mauritius and Singapore are grandfathered can now breathe easy as the department's circular is binding on tax authorities," Janssen-Sanghavi said.
The entire issue surrounding the applicability of the PPT arose last year when the India-Mauritius tax treaty was amended to include this test. This amendment, however, did not clarify whether the PPT will be applicable to grandfathered investments.
In 2017, the India-Mauritius tax treaty was amended, which provided the right to tax capital gains to India. However, investments made prior to the amendment continued to be taxed in Mauritius irrespective of their timing of sale.
This led to confusion as to how the recently signed protocol will interact with the grandfathering provision as stipulated in 2017. This triggered the need for issuance of clarification as various representations were made for such confirmation, according to Rahul Charkha, partner at Economic Law Practice.
By explicitly stating that the PPT will not be applied retroactively and that grandfathering provisions in tax treaties with Singapore, Cyprus and Mauritius remain in effect, the uncertainty is removed regarding the treatment of existing investments, according to Amit Maheshwari, partner at AKM Global.
The clarification will bring cheer to the foreign institutional investors about their apprehension of their past positions being exposed, Charkha noted.
The clarification will bring cheer to the foreign institutional investors about their apprehension of their past positions being exposed, Charkha noted.
Room For Doubts
Experts believe that though the clarification serves as a critical point for the interpretation of the PPT clause in tax treaties, it has left some questions unanswered.
There is no guidance with respect to application of the PPT in cases where a taxpayer satisfies limitation-of-benefits clause in the DTAA, said Vishwas Panjiar, partner at Nangia Andersen LLP.
The LoB clause is supplementary to the PPT clause and it denies treaty benefits to a taxpayer if one of the main purposes of a transaction is to obtain such benefits.
The clarification issued by the government says that the application of the PPT is supposed to be context-specific and fact-based. The clarification says that tax authorities may refer to relevant articles of the OECD and UN commentaries while applying the PPT.
Charkha remarked that an insight into the specific aspects like substance requirements, audit approach and the like would have provided more certainty.
Janssen-Sanghavi stated that tax authorities can subjectively deny treaty benefits, "if it is reasonable to conclude" that gaining treaty benefits was a principal purpose of a structure. There is, however, no guidance with respect to when it is reasonable and when it is not.
Nevertheless, Maheshwari pointed out that in a recent case involving a Luxembourg-based LLC, the tax authorities sought to deny treaty benefits by alleging a lack of economic substance and beneficial ownership. However, the tax tribunal ruled in favour of the taxpayer, emphasising that treaty benefits cannot be denied based on mere assumptions and without any evidence. This was the first Indian case dealing with the applicability of PPT.
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