The Central Board of Direct Taxes (CBDT) has issued fresh guidelines for applying the Principal Purpose Test (PPT) provisions under Double Tax Avoidance Agreements or DTAAs.
Revised Guidelines on Tax Treaty Benefits
- Clarifications: The revised guidelines ensure that past investments under DTAAs with Mauritius, Cyprus, and Singapore are not subject to scrutiny under the PPT rule.
- The changes apply prospectively and not retrospectively.
- Application: The PPT will apply only to new investments and arrangements that fail the genuine commercial purpose test.
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About Double Tax Avoidance Agreements (DTAAs)
- DTAAs are treaties signed between two or more countries to prevent the same income from being taxed twice.
- Avoidance of Double Taxation:
- These agreements ensure taxpayers are not subjected to taxes on the same income in both the source country (where the income is earned) and the residence country (where the taxpayer resides).
- Income Covered:
- DTAAs cover various types of income, including business profits, employment income, dividends, interest, royalties, and capital gains.
- Guidelines for Taxation: DTAAs specify which country has the right to impose taxes on specific types of income.
Types of Double Taxation Relief
- Bilateral Relief:
- Provided through DTAAs signed between two countries.
- Agreements specify tax treatment for particular types of income to prevent double taxation.
- Methods of Relief:
- Exemption Method: Income is taxed only in one country, while the other exempts it.
- Tax Credit Method: Taxes paid in the source country are deducted from the tax liability in the residence country.
- Unilateral Relief:
- Provided by a country to its residents even without a DTAA.
- Example: Indian residents earning income in a country without a DTAA with India may receive relief under the Income Tax Act, 1961.
About Principal Purpose Test (PPT)
- Definition: PPT is an anti-abuse provision included in many DTAAs to prevent the misuse of tax treaty benefits.
Base Erosion and Profit Shifting (BEPS) Framework
- BEPS is an Organisation for Economic Co-operation and Development (OECD) and G20 initiative started in 2016 to combat tax avoidance by multinational enterprises (MNEs) using profit-shifting strategies.
- Purpose:
- Prevents MNEs from shifting profits from high-tax jurisdictions to low-tax or no-tax jurisdictions where little or no economic activity occurs.
- This practice erodes the tax base of higher-tax jurisdictions by using deductible payments like interest or royalties.
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- Objective: Under the Base Erosion and Profit Shifting (BEPS) framework, PPT assesses whether a business arrangement is genuinely commercial or created solely to avoid taxes.
- Key Mechanism: If the primary purpose of an arrangement is tax-saving, treaty benefits can be denied.
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Significance of the New Guidelines
- Provides legal certainty to investors regarding past investments.
- Prevents misuse of treaty benefits by ensuring compliance with the PPT rule for future investments.
- Aligns with international standards under the OECD’s BEPS framework to combat tax avoidance.
- Reinforces India’s commitment to maintaining a transparent and investor-friendly tax regime.
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