India issues guidance on the application of the Principal Purpose Test

On 21 January 2025, the Central Board of Direct Taxes (CBDT) of India issued a Circular clarifying the following:

1. The Principal Purpose Test (PPT) under tax treaties shall apply prospectively; and
   
   
2. The gains on transfer of shares acquired by residents of Mauritius, Cyprus, and Singapore in Indian companies prior to 01 April 2017 (Grandfathered Shares) will remain outside the purview of the PPT.
   
   

The PPT

The PPT is an anti-abuse provision which aims to deny treaty benefits if it’s reasonable to conclude that one of the principal purposes of the arrangement or transaction was to benefit directly or indirectly from that treaty unless the granting of the benefit was in accordance with the object and purpose of the treaty. 

It relates to the prevention of treaty abuse under Action 6 of the Base Erosion and Profit Shifting project (“BEPS”). As members of the BEPS Inclusive Framework, both Mauritius and India have committed to implement Action 6 which is a minimum standard under the BEPS project. 

The amending protocol signed on 07 March 2024 which is intended to introduce the PPT in the Mauritius-India tax treaty has not yet entered into force.
 

Prospective application of the PPT

The circular confirms that if the PPT provision is included bilaterally by way of an amending protocol, the PPT will apply from the date of entry into force of the protocol.

The Circular also clarifies that, although the PPT will not be applicable, specific provisions agreed in the respective treaties (e.g., the Limitation of Benefits clause in the Mauritius-India tax treaty) will continue to apply.
 

The Grandfathering provisions

The Mauritius-India tax treaty has grandfathering provisions that exempt capital gains on sale of shares that a Mauritius resident company acquired before 01 April 2017.

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