Vinesh Kriplani & Rohan Umranikar


According to the Organisation for Economic Co-operation and Development (OECD), Base Erosion and Profit Shifting (BEPS) refers to tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax jurisdictions where there is no or little economic activity.  The OECD identified 15 Actions to address BEPS comprehensively and contained recommendations that fall into different categories – minimum standards (which all parties agree to implement), reinforced international standards and common approaches. 

In order to facilitate an accelerated and coordinated implementation of tax treaty based BEPS measures, Action 15 suggested the creation of a MLI to simultaneously amend the tax treaties of consenting countries to avoid the time-consuming process of bilateral negotiations for amending tax treaties.  The MLI was developed and agreed in November 2016 by approximately 100 jurisdictions, including OECD member countries, G20 countries and other developed and developing countries. 

The MLI enables countries to implement treaty-based BEPS recommendations contained in final reports of Action 2 (Hybrid Mismatch Arrangements), Action 6 (Prevention of Treaty Abuse), Action 7 (Prevention of Artificial Avoidance of PE Status), and Action 14 (Dispute Resolution Mechanism) in their tax treaties on the principles of matching of their choices. Post signing of the MLI, the provisions of the tax treaty will need to be read alongwith the MLI provisions. 

Countries can apply optional or alternative provisions, which must be notified to the OECD, and can also opt out of certain provisions (completely or partially) by making a reservation. Countries can also choose which of their existing treaties will be modified through the MLI (“Covered Tax Agreements” or “CTAs”).  A country’s set of CTAs, notifications and reservations is labelled the “MLI position” and its final version is published once each country has ratified the MLI, following domestic ratification procedures.  Once a country has ratified the MLI, its effects can be broadened by, for example, withdrawing a reservation or adding additional treaties to that country’s list of CTAs.  However, new reservations cannot be made and existing notifications cannot be withdrawn.  Typically, a provision of the MLI would amend the CTA based on the matching principle i.e. only when the provision is accepted by both the parties.  In certain instances, the MLI allows an asymmetrical application as well.

68 countries, including India, signed the MLI for amending their treaty network on the day of the signing ceremony in Paris on 7 June 2017 and a further 10 countries have subsequently followed suit, making 78 signatories so far.  6 more countries have committed to sign.  The power of the MLI can be gauged from the following statistics – The initial 68 signatories listed a total of 2,362 unique treaties in their MLI positions out of which 1,103 treaties will be modified based on matching the specific provisions that signatories wish to add or change within the CTAs nominated by them.

Effective date of the MLI modifications from an Indian perspective

The effective date of the MLI modifications would depend on when the domestic ratification procedures are completed and the final MLI positions alongwith the ratification documents are submitted by India and its treaty partners to the OECD.  It is likely that the MLI modifications in India’s CTAs will be effective in the course of 2019. 

Changes under the MLI framework for preventing treaty abuse

The MLI changes with respect to treaty abuse fall within the minimum standard i.e. all countries need to implement these changes unless they will meet those minimum standards in alternative ways.  The changes are as follows:

MLI article Description Comments India’s position
Purpose of a tax treaty (Preamble) and additional language The Preamble of the tax treaty to clarify that the purpose of the tax treaty is not to create opportunities for non-taxation or reduced taxation through tax evasion or avoidance. Additional language to the effect that the countries desire to further develop their economic relationship and to enhance their co-operation in tax matters. This is a minimum standard and hence, is mandatorily to be incorporated in all CTAs.  Countries can make a reservation if the CTA has an existing equivalent wording. Preamble lays down the object and purpose of a tax treaty and plays an important part in treaty interpretation as held by the Indian Supreme Court in the landmark judgment of Union of India v. Azadi Bachao Andolan. Additional language is optional. As per the provisional notification, India is silent on its position and hence, the preamble will be added to the existing preamble but the additional language will not be added.
Principal purpose test (PPT) and Limitation of Benefits (LoB) One of the following alternative approaches to be adopted: PPTPPT with simplified or detailed LoB rules.Detailed LoB rule supplemented by anti-conduit rules Asymmetrical application is possible if both countries approve.  This is a minimum standard and hence, is mandatorily to be incorporated in all CTAs.   As per the provisional notification, India would adopt PPT and simplified LoB in its tax treaties.  Most countries have adopted only the PPT and have chosen not to allow asymmetrical applications of the SLoB.  Since PPT is a default test, only the PPT is likely to be incorporated in most of the CTAs.

PPT rule

The PPT rule has two parts:

  1. Reasonable purpose test

As per this test, a benefit under the CTA shall not be granted if it is reasonable to conclude that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit.

  • Object and purpose test

This provides a safe harbour.  Thus, even if the reasonable purpose test is satisfied, the benefit under the CTA shall be allowed if granting the benefit would be in accordance with the object and purpose of the CTA.

Interplay of the PPT rule with the General Anti-Avoidance Rule (GAAR)

Under the GAAR introduced in the Indian tax laws (ITL) with effect from 1 April 2017, wide powers are given to the tax authorities to disregard/ recharacterize transactions which qualify as “Impermissible Avoidance Arrangements”.  Since GAAR can override the tax treaty provisions, it becomes important to evaluate the interplay of GAAR with the PPT rule in order to determine availability of treaty benefits.

The Indian tax administration has clarified that adoption of anti-abuse rules in tax treaties may not be sufficient to address all tax avoidance strategies and the same are required to be tackled through domestic anti-avoidance rules.  If a case of avoidance is sufficiently addressed by LoB in the treaty, there shall not be an occasion to invoke GAAR.

The PPT rule is broader in its ambit than GAAR, since GAAR is triggered only if the main purpose of an arrangement is to obtain a tax benefit.  Furthermore, in order for GAAR to be triggered, one of the other ‘tainted’ elements also needs to be satisfied, i.e., creation of rights or obligations that are not at arm’s length or abuse of the ITL or lack of commercial substance or bona fides.  Therefore, it is unlikely for GAAR to apply if the reasonable purpose test of the PPT rule is not met.  However, if the reasonable purpose test is met but treaty benefit is available on account of the taxpayer meeting the object and purpose test of the PPT rule, GAAR may need to be independently evaluated.  It may be noted though that GAAR does not apply in case of income from transfer of investments made before 31 March 2017; there is no such grandfathering under the PPT rule. 

Impact for holding companies

The PPT rule and GAAR can have an impact on holding companies which do not have adequate substance.  Investors will therefore need to review their group structures to test their eligibility to avail treaty benefits. 

As per the Foreign Direct Investment (FDI) statistics[1], Mauritius, Singapore, Japan, UK, Netherlands, USA, Germany, Cyprus, France and UAE are the top 10 investor jurisdictions and account for nearly 87% of the FDI into India.

USA has not signed the MLI and Mauritius and Germany have not notified India as a CTA and hence, these treaties will not be amended under the MLI framework.  However, since the measures to address treaty abuse are part of the minimum standards, these measures will eventually be part of these treaties as well through bilateral negotiations/ the MLI framework.  Thus, going forward, in order to avail treaty benefits, all holding companies would need to satisfy the PPT rule and the object and purpose test of the PPT rule would also be read in light of the amended Preamble.  This would be relevant in the following context:

  1. Direct transfer of the shares of an Indian company

Where the treaty provides for an exemption from Indian capital gains tax in case of transfer of shares of an Indian company (e.g. Mauritius, Singapore, Cyprus, Netherlands, Sweden).

  • Indirect transfer of the shares of an Indian company/ direct transfer of other capital instruments such as debentures, LLP interest

Where the transfer of shares of a foreign company would be subject to Indian capital gains tax on account of the indirect transfer provisions of the ITA but the treaty provides for an exemption (e.g. Germany, Italy, Switzerland, France, Luxebourg, Finland, Korea, Thailand, Mauritius, Singapore, Cyprus, Netherlands, Sweden).

The India-Singapore, India-Mauritius[2] and India-Cyprus tax treaties have been recently amended through bilateral negotiations.  As per the grandfathering provisions in these amended treaties, capital gains from transfer of shares of an Indian company, which were acquired before 31 March 2017, are not taxable in India.  In the case of the India-Singapore tax treaty, this grandfathering is subject to LoB conditions.  An interesting question that would arise is whether the PPT rule can be invoked to deny treaty benefits where these have been bilaterally negotiated and granted to investments made before 31 March 2017.  A reasonable interpretation would be that the PPT rule would apply; however, given the specific negotiations, the grandfathering benefit may be regarded as being in accordance with the object and purpose of the treaty and hence, the exemption being allowed (subject to satisfying the other treaty eligibility conditions including LoB under the India-Singapore tax treaty).  Also, GAAR would not apply in these cases given the grandfathering under GAAR.

Concluding thoughts

The PPT rule within the MLI framework alongwith the GAAR will significantly increase the threshold of substance required by holding companies to avail treaty benefits.  Taxpayers will need to be more conscious and cautious while setting up such structures as well as while exiting from existing structures given the subjective PPT rule. 

However, this is definitely not the end of holding company structures.  There are various commercial reasons for setting up holding companies (e.g. hedging business risk, protecting legal liabilities, creating an investment platform, raising funds, facilitating an exit route, regulatory reasons).  As we move into a new era of international taxation driven by substance over form and over-arching anti-avoidance rules, underlying documentation would be of paramount importance to substantiate these commercial considerations justifying the need for a holding company as well as the choice of its jurisdiction.  Taxpayers may be well advised to obtain advance rulings, where feasible, to mitigate the overhang of taxation.


[2] While Mauritius has left out its treaty with India from its CTAs, it has committed to implement the minimum standards by end of 2018 through bilateral discussions.  It would be interesting to follow the developments and understand how the two countries agree to apply the minimum standards, especially with respect to investments made before 1 April 2017

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