India tightens tax treaty with Sri Lanka
What's the story
India has amended its tax treaty with Sri Lanka, tightening loopholes in double taxation avoidance and preventing revenue leakage through treaty abuse. The move is aimed at eliminating double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance via treaty-shopping arrangements. The amended protocol was brought into force on June 19 this year and has now been notified by the Ministry of Finance.
New provision
Principal purpose test introduced in amended treaty
The amended treaty between India and Sri Lanka has introduced the Principal Purpose Test (PPT).
An anti-avoidance tool, the PPT ensures denial of benefits under a double taxation avoidance agreement (DTAA) if one of its principal purposes was to obtain a benefit under a treaty.
However, this is not applicable if granting such benefits is consistent with the object and purpose of the relevant treaty provisions.
Enforcement power
PPT empowers tax authorities to examine commercial intent
Tax authorities are now empowered to examine the commercial intent behind an investment structure and deny treaty benefits if obtaining a tax advantage is considered one of its principal purposes.
This is unless the arrangement is consistent with the treaty's object and purpose.
The PPT aims to ensure that DTAAs apply in accordance with their intended purpose, which is to provide benefits for bona fide exchange of goods and services, movement of capital and persons.
Expert views
Experts' views on amended treaty
Richa Sawhney, Partner at Grant Thornton Bharat, said the change in preamble will ensure that the treaty is not used to grant benefit in cases of double non-taxation and treaty shopping.
Amit Agarwal, Senior Partner at Nangia & Co LLP, said India's introduction of the internationally recognized PPT gives tax authorities power to deny treaty benefits where structures are primarily designed for lower tax burdens rather than real economic activity.
Global influence
PPT included in India's DTAAs
The 'Multilateral Convention to implement tax treaty related provisions to prevent Base Erosion and Profit Shifting' (MLI) came into effect for India on October 1, 2019.
The PPT is included in most of India's DTAAs through the MLI, and some other DTAAs through bilateral processes for countries such as Chile, Iran, Hong Kong, and China.