Context: Recently, Central Board of Direct Taxes (CBDT) has issued updated guidance for application of the Principal Purpose Test (PPT) under India’s Double Taxation Avoidance Agreements (DTAAs) to curb revenue leakages.

• New guidance exempts certain provisions under the India-Cyprus DTAA, India-Mauritius DTAA, and India-Singapore DTAA.

• Guidance also recognizes and nudges tax authorities to refer to Base Erosion and Profit Shifting (BEPS) Action Plan 6 as well as the UN Model Tax Convention (subject to India’s reservation on specific matters) for a supplementary source of guidance.

• BEPS Action Plan 6 addresses treaty shopping (use of tax treaties to reduce tax liability by routing investments through countries with favorable tax agreements) through treaty provisions.

What is Principal Purpose Test (PPT)?

• It is a part of international tax rules aimed at preventing misuse of tax treaties. 

• It is a key provision under the Multilateral Convention to Implement Tax Treaty related provisions to prevent BEPS, which entered into force for India on October 01, 2019.

• This Convention also modified some India’s DTAAs.

• Under BEPS framework, PPT checks whether a business arrangement is genuinely commercial or created mainly to avoid taxes. 

What is Double Taxation Avoidance Agreements (DTAAs) ?

• These are bilateral treaties aimed at preventing the same income from being taxed twice.

• Primary objective of DTAAs is to mitigate the tax burden on taxpayers by clearly defining the taxing rights of each country involved, thereby fostering cross-border trade, investment, and economic cooperation.  

• Key Provisions of DTAA include allocation of taxing rights among member countries, prescribing tax rates, exchange of tax-related information between tax authorities, etc.