The Central Board of Direct Taxes (CBDT), has clarified that past investments made under certain tax treaties with countries like Mauritius, Cyprus, and Singapore will not be affected by a new rule called the Principal Purpose Test (PPT).

The circular issued Wednesday move puts to rest industry concerns that their past investments might be reopened for scrutiny and clarify this aspect of retrospective vs prospective application of the Protocol to avoid any confusion or unnecessary litigation.

This is a big relief for taxpayers and investors who do business across borders with these countries. In April, 2024, India and Mauritius amended their double-taxation avoidance agreement and included a clause which said revenue authorities would now scrutinise the exemption available under the treaty as per the Principal Purpose Test laid down in the protocol.

What is principal purpose test?

In the global tax treaty, signed by both India and Mauritius, there is Base Erosion and Profit Shifting (BEPS) rules under ‘pillar two’ model, which is crafted to ensure large MNCs pay a minimum level of tax on income arising in each jurisdiction they operate in.

As per the BEPS rules there is provision to decline the shelter of a DTAA cover if the principal purpose of a business arrangement is to save tax and is gauged by using a Principal Purpose Test.

The protocol was amended in line with the provisions of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting that both countries have joined. Mauritius at that time had not included India as a treaty partner to whom the MLI would apply.

Both the country agreed to amend the treaty bilaterally.

Why this clarification is important?

The revised language in the amendment specifically stated that relief under the treaty cannot be for the indirect benefit of residents of another country.

This meant that revenue authorities would now scrutinise the exemption available under the treaty as per the Principal Purpose Test laid down in the protocol.

Experts that time pointed out that though the protocol would come in into force from a future date, based on past practice, it is likely to be applied even for shares acquired before April 1, 2017.

They feared it would be imperative for the FPIs to prove that there is a sufficient non-tax justification and commercial rationale for them to be based in Mauritius in order for them to claim the treaty benefit.