Cha pte r 7

Pr eve nti ng tre aty ab use in the

con tex t of multilateral
ins tru me nt
Dinesh Kanabar and Saurabh Shah *

Synopsis
7.1 Introd uction ........................................... ........................................................ 161
7.1.1 Treaty shoppi ng: an age-old concer n ......................................... 163
7.1.2 Evalua tion of "substance" principle in the Indian
contex t .......................... ................................................................. 164
7.1.3 BEPS Action Plan 6: preven ting the grantin g of treaty
benefi ts in inappr opriat e circum stance s .................................... 166
7.2 Multil ateral Instru ment ('MLI') .................................................................... 167
7 .2.1 Brief overvi ew ............. ,................................................................. 167
7.2.2 India's status on MLI .................................................................... 169
7.3 Preven tion of treaty abuse: Article 7 of the MLl.. ....................................... 169
7.3.1 Briefo vervie w ............................................................................... 169
7.3.2 India's stand on PPT and SLOB ................................................... 171
7.3.3 PPT impac t for India's key treaty partne rs ................................. 171
7.3.4 Scope and impac t of PPT ............................................................. 173
7 .3 .5 Other issues aroun d applic ation of PPT ..................................... 177
7.4 Concl uding remark s ...................................................................................... 179 II
11

7 .1 INTRODUCTION
Doub le Tax Avoid ance Agree ments ('DTM s' or 'Tax Treaties') is a form
of an agree ment entere d into betwe en two count~ies that typically
allocates taxing rights amon gst source country and residence country for

* Dinesh Kanabar is the CEO, and Saurabh Shah is a senior tax professional, at Dhruva Advisors.

161
Essays on Internati onal Taxation : Liber amicorum - Nishith Desai Chapter 7

various streams of income. Whilst the applicat ion of tax treaties resolves
the problem of juridical double taxation (i.e. same income being taxed in
the hands of same person in two differen t jurisdict ions), there have been
several instance s where applicat ion of tax treaties also results in double
non-tax ation. While double non-tax ation may very well be the object and
purpose which the treaty negotiat ors had in mind, what has been an area
of widespr ead concern in recent times is the misuse of such beneficial tax
treaty provisio ns by persons who are actually resident s of third States and
not resident s of respecti ve treaty countrie s.
For instance, there have been several cases in public domain where a
taxpayer has invested in India via Mauritius solely to get the potential treaty
benefit on capital gains in future. There have also been cases where
substantial amounts of profits were parked in low tax jurisdictions (where IP
is located) and a negligible portion thereof was attribute d to market/source
jurisdiction - a strategy adopted by quite a few global MNCs. Whilst the
arrangem ent may be perceived to be within the four comers of law,
questions arose as to whether the MNCs are paying their 'fair share of taxes'
or are simply manipulating the international tax mismatc hes/rule s in order
to achieve NIL or negligible taxation at an overall Group level.
In order to, inter-alia, prevent such Base Erosion and Profit Shifting
('BEPS') measure s, the OECD launche d an ambitio us project in year 2013
wherein various Action Plans (includi ng prevent ing abuse of tax treaty)
were identifie d and delibera ted includin g obtainin g an international
consens us on several of them. The BEPS project thus represen ts the
single most importa nt multilat eral initiative in the field of international
tax in recent memory. The objectiv e of this project was to revise
prevaili ng internat ional tax rules so as to eliminat e gaps and mismatches
that enabled the shifting of profits to no or low-tax jurisdictions. It was
widely felt that in addition to loss of revenue for governm ents, BEPS also
underm ined the integrity of the overall tax system.
Several recomm endation s of the BEPS project are being impleme nted
1
through "Multilateral Convent ion"/"M ultilater al Instrum ent" ('MLI')
which incorpor ates various treaty related provisio ns identifie d as part of
the final BEPS measures. Once the ·MLI is effective, the existing tax treaty
will need to be read along with the provisio ns as opted for under the MLI

Realisin~ the near superhuman efforts which would go into re-negotiating the 3000 odd tax treaties in
0rder t~ implement the BEPS measures, the OECD has provided for a unique solution in the fonn of
a Multilateral Tax Convention; which is a a single instrument by which countries will be able to
amend up to 3,000 bilateral treaties.
Chapter 7 · th e context of multilateral
Preventing treaty abu se 1n . .
mstrument

by the respective countries · The d.1scuss1on

· 1n· t h e ensuing
· paragraphs 1s
·
largely ~ocussed on how treaty abuse is sought to be prevented in the
current international tax framework.

7. 1 .1 Treaty shopping: an age-old concern

Treaty abuse has long been one of India's foremost concerns in relation
to cross-border taxation. Accordingly, various measures have been
adopted by India, both at unilateral and bilateral level, to help curb its
incidence. For instance, amendments in domestic tax law (such as the
requirement to furnish a Tax Residency Certificate, requirement to obtain
a Permanent Account Number, providing for treaty override in cases
where General Anti-Avoidance Rule ('GAAR') is applied) and insertion of
a Limitation on Benefits ('LoB') clause in recently negotiated tax treaties
with Mauritius, Singapore and Cyprus are steps in this direction.
Globally, too, concerns over treaty abuse are on the increase including
the morality debate and increased expectations from the stakeholders
(Governments, investors and consumers) that businesses must pay their
'fair share of taxes'. This trend was reflected in the final reports of the
OECD Base Erosion and Profit Shifting ('BEPS') Project. Specifically, the
work relating to preventing of treaty abuse through inclusion of a
'Principal Purpose Test' ('PPT') and LoB test in tax treaties (through the
Multilateral Instrument) represents a significant step in this direction.
The BEPS concerns have succinctly been expressed by Pascal Saint
Amans2 in the following words (before the United States Committee on
Finance in July 2014):
"... the current consensus-based international frameivork is. at
risk. First, it no longer fully meets its objectives of allocating
taxing rights between co~ntries where companze~ opera_te.
Instead, it facilitates the divorce between the location ~f the
profit and the location of value creation. :"he consequence zs _that
the existing international tax system in many case~ allow~i'
structures and tax results that no longer ~ass a _basic test o1
se For example, as taxpayers increasingly r~ly on
common sen · . ·t h becorne easier for
1
intanuible assets as a value-dnver, as .~ l
0 ~ • ti rinciples to trans1 er ega 1
taxpayer~ to rely .o; e~:le n:Ss~s to "cash boxes" in low-tax
ownership of those in angi ,f:it but erfonn no or
jurisdictions that receive a large share of pro1. p

2 Director, Centre for Tax Policy and Administration, OECD.

163
 Essays on International Taxation: Liber amicorum - Nishith Desai Chapter 7

hardly any activity. Trillions of untaxed dollars are now located

in such entities, in compliance with the existing rules. It is hard
to imagine that this is what was intended when these rules were
designed. Another striking example is where the features of a
bilateral treaty cause investments in one country to be
channeled through a particular jurisdiction by third-country
investors. For example, as shown in IMF data, more than one
quarter of direct investment into India was from Mauritius
between 2010 and 2012."
Over the years, the OECD has acknowledged that while tax treaties need
to be respected and the principle of "pacta sunt servanda" (agreements
must be respected) apply, the countries may not be prohibited from
dealing with the cases of treaty abuse. For this purpose, the countries
may be permitted to apply measures which can be introduced in their
domestic law to deal with treaty abuse which could either be in the form
of legislative provisions or could be in the form of judicial principles on
the doctrine of" substance over form".

7 .1.2 Evaluation of "substance" principle in the Indian context

Prior to introduction of GAAR and PPT, the Indian courts have dealt with
the concept of 'substance over form' in a number of cases. For instance,
the Supreme. Court in the case of Azadi Bachao Andolan 3 was concerned
with the validity of Circular no 789 issued by the Central Board of Direct
Taxes granting treaty protection to Flis based out of Mauritius holding a
valid Tax Residency Certificate. The Supreme Court upheld the validity
of the said Circular and did not regard treaty shopping to be an
unacceptable tax avoidance exercise. Similarly, in the case of Vodafone
International Holdings B. V. 4, the Supreme Court, inter alia, preferred a "look
at" approach over a "look through" approach by holding that sale of shares
of foreign companies are not taxable in India even if they derive their
value substantially from India. The Supreme Court acknowledged that in
absence of a specific anti-abuse mechanism, it is not open for the Courts
to read such mechanism into a statute/treaty when there is none. Further,
way back in the year 1968, the Supreme Court in the case of A.Raman &
5
~o held that avoidance of a tax liability by arranging commercial affairs
1n such a manner that charging of tax is distributed is not prohibitive.

3
~nion of India & ~- v Azadi ~achao Andolan & Anr., [2003] 263 ITR 706 (SC).
4
odafone International Holdmgs B.V. v Union of India, [2012] 341 ITR 1 (SC).
5
CIT v A. Raman & Co [1968] 67 ITR 11 {SC).

164
 Chapt er 7 Preve nting treaty abuse in the contex t of multil ateral instru ment

Whils t the Supre me Cour t in the case of McDowell 6 has held that
color able devic es cann ot be part of tax plann ing and has depar ted
from the Westministers 7 princ iple of tax plann ing, there are sever al
prece dents whic h have asser ted that there is per se no conflict
betw een the McD owell 's and Azad i Bacha o Ando lan's case. For
instan ce, in the case of Vodafone (supr a), after elabo rately notin g the
argum ents of the taxpa yer and the tax depar tmen t and also after
notin g the obser vatio ns of the mino rity and major ity views expre ssed
in case of McD owell , the Supre me Cour t concl uded that per se there
was no confl ict betw een McD owell 's decis ion and Azad i Bacha o
Ando lan' s decis ion as the princ iples laid down unde r the decis ions
were towa rds the groun ds that tax plann ing withi n the frame work of
law was accep table and only if the same was tainte d by use of dubio us
meth ods or subte rfuge s, the same woul d be const rued as
impe rmiss ible tax avoid ance. The relev ant obser vatio ns of the
Supre me Cour t in this regar d are repro duced below :
llThe majo rity judgm ent in McDowell held that "tax planning
may be legi.timate provided it is withi n the framework of law"
(para 45 ). In the latter part of para 45, it held that "colourable
device cann ot be a part of tax planning and it is wrong to
encourage the belief that it is honourable to avoid paym ent of
tax by resor ting to dubious methods". It is the obligation of every
citize n to pay the taxes witho ut resorting to subterfuges. The·
above obser vatio ns shoul d be read with para 46 where the
majo rity holds I✓on this aspect one of us, C~innappa Re~dy, ].
has propo sed a separate opinion with which we agree_ .. The
word s "this aspect" express the majority's agre~ment with the
judgm ent of Redd y,]. only in relation to tax evaszo~ through the
use of colourable devices and by resorting to dubious me~ho~s
and subte rfuge s. Thus, it canno t be said that all tcec plann~ng zs
ille al/ill egitim ate/im perm issibl e. Moreover: Reddy, ]. himse lf
sa';s that he agrees with the majority. In the Judgment of ~edd~,
J there are rep ea te d re'ere:1 •
nces to schemes and devices in
. b ·z · ,, (
;ontr adist inctio n to "legitimate avoidance of t~x 1ia l ·ity paras
7-10, 17 & 18). In our view, although Chinnappa Reddy, ].

. 1Tax Officer, [1985] 154 ITR 148 (SC). . .

6 Mc Dowell & Co. Ltd. v The Commercta . . C l · 19 TC 490), every man is entitle~ if
7 As per the principles laid down in Duke of W~~tmm1s~:: ~t~ a~p~opriate Acts
is less than it otherwise
he can to order his affairs so that the tax attac mg un
would be.

165
Essays on Internation al Taxation: Uber amicorum - Nishith Desai Chapter 7

makes a number of observations regarding the need to depart

from the 'Westmins ter" and tax avoidance - these are clearly
only in the context of artificial and colourable devices. Reading ,
McDowell , in the manner indicated hereinabove, in cases of
treaty shopping and/or tax avoidance, there is no conflict
between McDowell and Azadi Bachao or between McDowell
and Mathuram Agrawal."
There have been several other cases which have held that the decision in
McDowell could not be read as proclaimin g that every attempt at tax
planning was illegitimate and should be ignored, or that every
transactio n or arrangeme nt which is permissibl e under the law but that
reduces a taxpayer's burden should be looked upon with disfavor. The
Azadi Bachao Andolan case supersede d the McDowell case and held that
Duke of Westminister continues to be a good law. In fact, Justice Srikrishna
specifically brought this out in the ruling in Azadi Bachao Andolan saying
that the views of Justice Chinnapp a Reddy in the McDowell ruling
represente d an "extreme view" which "actually militates against the
obseroations of the majority of the judges".
Given the advent of GAAR and PPT, the principles emerging from such
judicial precedent s around tax planning and tax avoidance will assume
significan t importanc e in the times to come.

7 .1.3 BEPS Action Plan 6: preventin g the granting of treaty

benefits in inapprop riate circumstances
Addressin g treaty abuse and treaty shopping is widely seen as one of the
most important areas dealt with as part of the BEPS project. Particularly,
this assumes relevance in the Indian context, mindful of the Indian
Governme nt's long stated concerns on the subject.
The BEPS Report had recommen ded the following three-pron ged
approach to counter treaty abuse/shopping strategies;
(a) Minimum Standard: Inclusion in tax treaties of a clear
statement /preamble that treaties are entered to avoid
creating opportuni ties for non..taxation or reduced taxation
through evasion or avoidance including treaty shopping
arrangeme nts. Countries have committe d to ensure this as a
minimum level of protection against treaty shopping ("the
minimum standard") .
(b) Compreh ensive Limitatio n on Benefits Article: A specific
anti-abus e rule in the form of a comprehe nsive Limitation

166
Cha pter 7 Pre ven ting trea ty abu .
se in the con text of multilateral inst rum ent

on Ben efit s ( 'LOB') A .

Mo del Con ven tio rbc~e to be inc lud ed in the OECD
e of various
con diti ons bas ed n, whi ch will compris
ow ner shi p, gen era l a~nt·1v1'tf~c tors suc h as legal nat ure '
. . ies etc,
(c) .
Pri nci pal Pur pos e Test: In or add ress oth er forms
of trea ty abu se tha t wo uld .der to
cla use , a mo r not be cov ere d wit hin the LOB
'P . . l Pur pos e gen era l ant i- a b use ru Ie bas ed on a.
nnc 1pa e Tes t'
inc lud ed in
the OE CD Mo del Con v or_ a PPT rule to be
rule, if one of
the pri nci pal pur pos es o~~ ~;n . Unde~ this
is to obt ain trea ty b f't tran sac tion or arra nge men ts
ene I s the ben efit Id b d
hed th; t th . s wo u e . eni ed
unl ess it is esta blis e gra ntin g of suc h benefits
wo uld b · th b.
e in acc ord anc e wit h e O Ject and pur pos e of
the trea ty.

The afo resa id rec om melnda ti h b

tex t of the Mu ltila tera I ~n s ave ~en _suit~bly incorporated in the
ns me nt which is discussed in the ensuing
par agr ap h s.

MULTILATERAL INSTRUMENT ( MLI')

1
7.2

7.2.1 Brief overview

the international tax law of
Tax trea ties rep res ent an imp orta nt aspect of
tax treaties are currently in
ma ny cou ntri es. Ov er 3,000 bilateral income
re have historically been
effect, and the num ber is stea dily growing. The
example is the Multilateral
very few mu ltila tera l inc om e tax trea ties (one
nce in Tax Matters). With
Con ven tion on Mu tua l Administrative Assista
tal technology in the recent
the adv ent of glo bal izat ion and gro wth of digi
countries' tax systems have
times, the gap s and frictions am ong different
D BEPS project in 2012.
exa cer bat ed, pav ing the way for the OEC
ch would go into re-
Realising the nea r sup erh um an efforts whi
OECD has provided for a
neg otia ting the 300 0 odd tax treaties, the
Convention.
uni que sol utio n in the form of a Multilateral Tax
ltilateral Convention was
In No vem ber 201 6, the mai n tex t of the Mu
countries will be able to
agr eed - this is a sing le ins trum ent by which
am end up to 3,000 bila tera l treaties. It, inter
alia, includes clauses ~hi ch
treaty abuse and dispute
relate to the BEPS min imu m stan dar ds on
visions and options where
reso luti on, as wel l as oth er opt -in/opt -ou t pro
the re are mu ltip le way s to add ress BEPS.

167
 ith Desai
E~suys Otl Inte rnat iona l Taxation: Libe r ami coru m - Nish Cha pter 7

ed
The BEPS pro ject has led to a seri es of mea sure s bein g dev elop across
· ty
" I
sev era Act~on s such as taxa tion of digital eco nom y, add ress ing trea
y Rules, intangibles,
ab us~ , des ign of Con tr?l led Foreign Com pan
l avo idan ce of PE status,
~ou n tr~-by- c~u ntry rep orti ng, pre ven ting artificia
e mea sure s required
~1n pro v1n g d~sp ute reso luti on etc. Several of thes
.
1111ple n1 ent atio n thro ugh cha nge s in dom esti c law
lem enta tion through
As reg ard s ~hose 111easures whi ch req uire d imp
tila tera l convention that
ch ang es to bila tera l trea ties , it was felt tha t a mul
ld be preferable as it
1n odified the exis ting bila tera l trea ty netw ork wou
tion .
wou ld ens ure spe ed and con sist enc y in imp lem enta
rpo rate s the following
Acc ord ingly, the 1nultilateral con ven tion inco
l BEPS measures:
h·ea ty rela ted mea sure s iden tifie d as par t of the fina
arrangements
• Neu tral isin g the effects of hyb rid mis mat ch
(Ac tion 2)
Inappropriate
• Pre ven ting the Gra ntin g of Tre aty Benefits in
Cir cum stan ces (Action 6)
Establishment
• Pre ven ting the Artificial Avo idan ce of Per man ent
Sta tus (Action 7)
e effective
• Ma kin g Dis put e Res olu tion Me cha nism s mor
(Ac tion 14)
of the MLI are called as
The tax trea ties whi ch stan d modified on acc oun t
✓Covered Tax Agr eem ents ' ('CTA'). Onc
e the MLI is effective, the existing
provisions as opted for
tax trea ty will nee d to be read alon g wit h the
, it is per tine nt to note
und er the MLI by the resp ecti ve countries. Further
ty only whe re both the
tha t the pro visi ons of MLI shall app ly to a tax trea
list of treaties which are
cou ntri es hav e listed eac h oth er in the respective
a particular provision
to be mod ifie d by the MLI and hav e also opt ed for
tchi ng concept'). For
on an iden tica l prem ise (popularly kno wn as 'ma
ar clause of MLI would
exa mpl e, in ord er to dete rmi ne whe ther a particul
Cou ntry B), one ':ill
imp act a tax trea ty (say betw een Cou ntry A and
by bot h the countries
nee d to first che ck the MLI positions sub mit ted
k of the various MLI
wit h resp ect to tha t clause. In ord er to keep a trac
D has released a MLI
pos itio ns ado pted by eac h of the countries, the OEC
extracted from the MLI
Matching Dat aba se8 whi ch gives a tabu late d data
pos itio ns pro vid ed by eac h country.

htm.
http://www.oecd.org/tax/beps/mli-matching-database.

168
Chap ter 7 Preve nting treaty b .
a use in the conte xt of multilateral instru ment

7..2.2 India's status on MLI

The Gov ernm ent of India has de .
25 June 2019 with the OEC D posit ed the ratified copy of the MLI on
. alon g with 1·t 5 1·1st of tax treat ies that
In d 1a wan ts to mod ify th roug h the MLI ·
d · final
· on vario us art' an its posit ions and
reser vatio ns 1
notif ied 93 tax treat ies i e ilcl 1~tss of the MLI. In this regar d, India has
· ·a · e tax treat ies exclu ding
com pr e h ensiv
Chin a.
The MLI shall ente r into force £ 1 d.
28 June 2019, in addi tion to I d~r ; ia on 1 Octo ber 2019. Further, as of
0th sited
the ratified MLI with the 0 ~;, h . ~r countries have also depo
major
treat y partn ers such as Aust ral~ i~h includes some of India's
Sing apor e and the UK Such tre ti1a, hralanl ce, The Netherlands, Japan,
. , a es s now qualify as CTA d fr om
India s persp ectiv e, the MLI shall be efl . . an
ective with respect to these CTAs
from 1 April 2020 (i.e. AY 2021-22).

7.3 PREVENTION OF TREATY ABUSE: ARTICLE 7 OF THE MLI

7.3.1 Brief over view
to curb
Article 7 envi sage s the follo wing 3 appr oach es in bilateral treaties
treat y abus e:
(a) A Princ ipal Purp ose Test ('PPT')
(b) A Simp lified Limi tatio n on Benefits clause ('SLOB')
{c) A Deta iled Limi tatio n on Benefits clause ('DLOB')
respect
The PPT state s that bene fits unde r a treat y will not be available in
having
of an item of inco me or capit al if it is reaso nable to conclude.,,
benefit
regar d to all relev ant facts and circumstances, that obtaining that
n that
was one of the princ ipal purp oses of any arran geme nt or transactio
will be
resul ted direc tly or indir ectly in that benefit. However, the benefit
these
available if it can be estab lishe d that gran ting that benefit in
of the
circu msta nces wou ld be in acco rdan ce with the object and purp ose
relev ant prov ision s of the treaty.
able
The SLOB artic le prov ides that treat y bene fits will not be avail
de,
unle ss the resid ent is a 'qual ified perso n', whic h is defin ed to inclu
local
(i) an indiv idua l; (ii) cont racti ng state , political subd ivisi on,
(iv) a
auth ority ; (iii) com pany who se shar es are regu larly tr~ded;
e~ al.
resid ent who is enga ged in activ e cond uct of_ a bu~1~ess;
ided
Specifically in the cont ext of activ e trad~ or_ busin ess, 1t 1s_ prov
not . be
that the follo wing activ ities or a comb1na~1on the~eof will
ing
cons idere d as an activ e trade or busin ess: (1) oper ating as a hold
169
 Essays on Internat ional Taxatio n: Uber amicoru m - Ni.shl.th Desai Chapter 7

compa ny; (ii) provid ing overall superv ision or admini stratio n of a
group of co1npanies; (iii) provid ing group financi ng (includ ing cash
poolin g); or (iv) making or 1nanag ing investm ents, unless these
activiti es are carried on by a bank, insuran ce compa ny or' registe red
securit ies dealer in the ordina ry course of its busine ss as such.
The MLI also conte1nplates a more 'detaile d' Limitation on Benefits
clause. Howev er, it provide s that this will need to be negotia ted by
parties in a bilateral context.
It is pertine nt to note that the adoptio n of the PPT is manda tory (acts as a
"miniin unt standard"), and it is not open for countri es to exclude its
applicability except in very limited and specific circumstances. However,
these exclusions do not apply in an Indian contex t, and hence, the PPT
forms part of all of India's Covere d Tax Agreem ents. Howev er, it may be
noted that China9, Germa ny, Maurit ius and Oman have indicat ed that
the agreem ent with India has not been listed under the MLI and that
these countri es would bilaterally negotia te with India in order to comply
with the minim um standar d. Hence, the PPT will not be applicable in
India's tax treaties with the aforesa id countri es·.
Whilst the above PPT rule is largely in sync with the guiding principle of
paragr aph 61 10 of the OECD Comm entary on Article 1, the inherent
subjectivity couple d with the broad langua ge of the provisi on is an area
of widesp read concern. Whilst we will discuss the scope and impact of
PPT in greater detail in the subseq uent paragr aphs, broadly speaking, in
order to deny the treaty benefits, the tax authori ties only need to
substan tiate that it is "reason able to conclude" that "one of the principal
purpos es" of any arrang ement or transac tion was to obtain a treaty
benefit. As such, the tax authori ties are left with much discretion in
interpr eting the require ments of the PPT.
To illustrate, can the PPT be invoked in a situation where inbound
investments into India are made by a US multinational throug h a holding
compa ny in The Netherlands? Can PPT be invoked if equipm ents are leased
to India throug h a leasing entity in The Netherlands which-may have back to

9
Treaty with China has already been amended vide Notification No. S.O. 2562(E) [No.54/2019/F.No.
503/02/2008-FTD-ll], Dated 17-7-2019 which includes the Principal Purpose Test and other
measures which have been adopted in the Multilateral Convention.
JO
The guiding principle is that the benefits of a double taxation convention should not be available
where a main purpose for entering into certain transactions or arrangements was to secure a more
favorable tax position and obtaining that more favorable treatment in these circumstances would be
contrary to the object and purpose of the relevant provisions. That principle applies independently
from the provisions of paragraph 9 of Article 29, which merely confirms it.

170
Chapter 7 Preventing treaty abuse in th .
e context of multilateral instrument
back lease arrange1nents with Ja 7 C
invesbnents are made in India :an. han PPT ?e
invoked in cases where
which satisfies the Limitation of Br;~fi a('~old~ng co~~any in Singapore
Can PPT be invoked if loan is t k fr ts LOB ) conditions of the treaty?
banking business in Mauriti a then om a bank which carries out bona.fide
us or e UK? The list can go on.
7.3.2 India's stand on PPT and SLOB
At present, India has opted for PPT along 'th SLOB ~ h
· · th . . ..
11g1b1hty ' WI , 1or t e purpose of
determ1n1ng
. :t e
. e for treaty benefits Th
. e PPT · a d e-tau·1t
, b'e1ng
option or me~!ing the minimum standard, does form part of all of India's
CTA. I~ addition to PPT, SLOB may or may not form part of CTA
depending 0 ~ the n:iatching position adopted by the other country. For
example: while l~~1a has notified its intention to adopt the option of
cumulative conditions of PPT as well as SLOB, countries such as
Australia, The Netherlands, Singapore, etc have merely notified PPT as
the norm acceptable to them. In such a case, based on the matching
principle, the PPT rule alone (being the minimum standard) will form
part of the CTA and the condition of SLOB will not be required to be
tested for India's treaties with those countries. However, for example, in
the context of Russia, which has adopted the PPT as well as SLOB-, the
India-Russia CTA will include the cumulative conditions of PPT as well as
SLOB. Essentially, India cannot unilaterally enforce the rule of SLOB as a
pre-condition in the implementation of CTA without the concurrence of
its counterpart treaty partner.
7.3.3 PPT impact for India's key treaty partners
Basis the current position adopted by the countries, th e applicability of
PPT to India's key treaty partner5. is t~bulated below:
tie;-
·
- ,·f. :the;. St~te·d
, ~JI •p·act
., ti~g ti~afy ~ii$ post~. Qn- an
~ 1r0Yision sim:Jlar M.LI
ttiPPT?
US has not Given that the US is not
us No
signed
the a signatory to the MLI,
there is no impact of
MLI.
PPT on existing India-
US Tax Treaty.
However, the existing
treaty has an Article on

171
 ith Desa i
Essay s on Inter natio nal Taxa tion: Libe r amic orum - Nish Chap ter 7

Country Whe ther the Stat ed Im.pact

exist ing treaty pas posi fian on 1

II

a prov ision similar MLI

to PPT ?
Limi tatio n on Benefits
(Article 24) which is
simi lar to the SLOB
prov ision of the MLI.

Sing apor e No. The LOB Sing apor e has PPT will apply . In
Article is limit ed to only opte d for addi tion to the PPT, the
Capi tal Gain s PPT (and not exist ing LOB clause
inco me. SLOB). (incl udin g the objective
crite ria for capital gains
exem ption ) will also
cont inue to apply.

Mau ritiu s No. The LOB Mau ritiu s has As Mau ritiu s has not
Ar ticle is limited to not notif ied notif ied India, base d on
Capi tal Gain s India in its list the matc hing principle,
inco me. of CTA. the prov ision s of MLI
(incl udin g PPT) do not
appl y to India-Mauritius
Tax Trea ty.
How ever , Mau ritius has
state d that bilateral
nego tiatio ns woul d be
carri ed out with India in
orde r to achie ve the
mini mum stand ard.

The No. The PPT will appl y.

Neth erlan ds Neth erlan ds
has only opte d
for PPT (and
not SLOB).

UK Yes UK has only PPT apply. The

will
in
opte d for PPT exist ing Iangu age
( and not Article 28C would be
SLOB). mod ified with language
of Article 7(1) of the MLI-

172
Chapter 7 Preventing treaty abuse in the context of multilateral instrument

-
Country J , Whether the Stated Impact
existing treaty has position on
, a pro\lision similar MLI
r,t o PP~?
T .,

Hongkong Yes (but only for Hongkong has No impact of MLI (and
limited Articles) not notified PPT) on India-
India in its list Hongkong Tax Treaty
ofCTA.

7 .3.4 Scope and impact of PPT

Article 7(1) of the MLI reads as under:
uNotwithstanding any provisions of a Covered Tax Agreement, a benefit
under the Covered Tax Agreement shall not be granted in respect of an
item of income or capital if it is reasonable to conclude, having regard
to all relevant facts and circumstances, that obtaining that benefit was
one of the principal purposes of any arrangement or transaction that
resulted directly or indirectly in that benefit, unless it is established that
granting that benefit in these circumstances would be in accordance
with the object and purpose of the relevant provisions of the Covered
Tax Agreement".
As can be seen, the PPT primarily comprises of the following two tests:
I

Reasonable Notwithstanding any provisions of a Covered Ta..-r I

purpose test Agreement, a benefit under the Covered Tax Agreement shall
not be granted in respect of an item of income or capital ~fit
(1 st limb)
is reasonable to conclude, having regard to all relevant facts
and circumstances, that obtaining that benefit was one of
the prindpal purposes of any arrangement or transaction
that resulted directly or indirectly in that benefit.

Object and unless it is established that granting that benefit in these

purpose test circumstances would be in accordance with the object and
purpose of the relevant prot1isio1is of the Couered Tax
(2 nd limb)
Agreement
1 st limb: Meaning of Hone of the principal purposes·
A transaction or arrangement can be considered to be tainted or of
oblique motive if one of the principal purposes is to obtain a treaty
benefit. As one of the plausible views, one can argue that a purpose may
be regarded a "principal" purpose when, but for treaty benefit, .a
transaction or arrangement would not have been concluded the way 1t

173
 urn - Nishith Desai
Essays on Inte rna tion al Tax atio n: Lib er am icor Chapt.€:, 7

eng ine ere d or m,, tiva·ted th,:

has bee n don e. Tre aty ben efit sho uld hav e
pa1 n 11 .
arr ang em ,ent or tran sact'
An oth er pla usi ble vie w cou ld be tha t an
wh ich is mo tiva ted by bus ine ss or com me
rcia l con sid eration s is n~;n
tran sac tion 1ne rely bec aus e the re is an inc ide nta l ben efit und er aa
tain ted
em ent is inextri cably linked
tax trea ty. As per the OEC D , w h ere an arr ang
form is not driven by
to the cor e com me rcia l act ivit y and its
unl ike ly to trigger PP'T.
con sid era tion of obt ain ing trea ty ben efit , it is
to the exa mp le given in the
In this reg ard , use ful ref ere nce can be ma de
R wh ich wa nts to set up a
OE CD rep ort of an ent erp rise in Co unt ry
icti ons we re considered, and
ma nuf act uri ng facility ove rse as. Th ree jur isd
uri ng facility in Countiy 5
it wa s eve ntu ally dec ide d to set up a ma nuf act
a beneficial tax trea ty with
as tha t wa s the onl y cou ntr y wh ich had
as per this first limb, one
Co unt ry R. For the sub jec tive tes t of the PPT
ntr y S, but to the motive for
sho uld loo k at the mo tive for cho osi ng cou
lt to obt ain trea ty benefits,
bui ldin g a factory. The fac tory is cle arly not bui
ly. Also, it is arguable that
and the ref ore the PPT sho uld arg uab ly not app
be in line with the object
gra ntin g trea ty ben efit s in thi s sce nar io wo uld
b of the PPT.
and pur pos e of the trea ty as per the sec ond lim
the prin cip al pur poses" have
No net hel ess , the fact tha t the wo rds "on e of
e', the 'essential purpose'
bee n cho sen ins tea d of e.g., for the 'sol e pur pos
.,pr edo min ant pur pos e', ma kes it rela tive ly eas y for the tax authorities
or
In abs enc e of strong and
to est abl ish tha t the sub jec tive tes t is me t.
cou ld be quite difficult to
ove rar chi ng com me rcia l con sid era tion s, it
not one of the principal
con ten d tha t obt ain ing a trea ty ben efit is
ort ant motives to cany out a
pur pos es if the tax pay er has two equ ally imp
sac tion , one tax rea son and one com me rcia l reason. In such a case,
tran
ly as the tax rea son cou ld be trea ted as one of th e
the PPT cou ld app
prin cip al pur pos es.
The bu~ines~ ~r ~ommercial considerat~o~s
ma y ~iffer v~~ wid:t
financmg, ability to ~ · d
Co nce ssio ns 1n 1nd1rect taxes, eas e of obt ain ing
internationally recogmz~e
stra teg ic/f ina nci al inv esto r, eas e of obt ain ing
nse s, effe ctiv e IPR pro tec tion law s, pre sen ce of a bilateral 1;;ain
lice
ent etc. could be ce
agr eem ent or an inv est me nt pro tec tion agr eem
en arrangement.
illustrative stro ng com me rcia l rea son s in a giv

11 29(9).
Para 181 ofOE CD Commentary 2017 on Article
 Pre ven ting trea t ab .
Ch apt er 7 trum ent
y use in the con tex t of mu ltila tera l ins

2nd limb: Object and pu rpo se tes t

Th e lat ter par t of the PPT .
by obs erv ing tha t eve n i'f onpro vf1des for a significant exce·p tio n/carve out
. . e o the · nci· pa.I pu~poses of an arr ang em ent
1s to ob tai n a tre aty ben efi
be est abl ish ed tha t gra nt of suc h
t,
::ty
the tr pri
~e~~fit will not be denied if it can
. . nefit Is in accordance with the object
and pu rpo se of the rel eva nt prov1s 1ons of CTA.
.
Giv en the wo rdi ngs of the PPT·t [Atrd1 r1 ( . .
carve
ou t is app lic abl e or sho uld b e es e conl e 7 1)], it can be said tha t the bl
y wh en the tax payer 1s ·
• fy ied in the firs t . b ( .
· una e to
satis the cri ter ia spe cif 1Im i.e. after the arr ang em ent is
est abl ish ed to be im · 1 • . 1
p em ent ed for one of th e pnn cip a pur pos es of
obt ain ing a tre aty ben efi t).
of reasonable conclusion on art of
It ma y be ~o ted t~a t the • req uir em ent h'l · p
taxt aut hor ity to trig ger the first limb of the PPT w 1 e requ1rement of
bl· h • ,, pur pos e on par t of taxpayer und er
es a is ing ~o acc ord wit h obj ect and
0

cant
th e sec on d l~n:1~ of the PPT has bee n a subject ma tter of signifi
deb ate and criticism. ·

A rec ent dec isio n of the Tax Co urt of Ca nad a in the case of Alta Energy
em bo~ rg ~.A .R.L . v The Qu een 12
pro vid es useful poi nte rs to the meaning
Lux
n was ren der ed in the context of
and app hca ho n of the PPT. Th e dec isio
sid iar y by a Luxembourg par ent
tra nsf er of sha res of a Ca nad ian sub
LLC. Un der Article 13(5) of the
com pan y, ult im ate ly hel d by a US
m such transfer were exe mp t in
Ca nad a-L uxe mb our g tre aty , the gai ns fro
by tax authority by invoking
Ca nad a. Th e tre aty ben efi t wa s den ied
tha t it inter alia involved abuse of
Ca nad ian GA AR pro vis ion s on pre mi se
ang em ent .
tre aty pro vis ion s by tre aty sho ppi ng arr
xem bo urg com pan y acc ept ed tha t it derived a tax benefit from
Th e Lu
US to Luxembourg. The taxpayer
res tru ctu rin g of ow ner shi p from the
ced ed tha t the res tru ctu rin g wa s not arranged primarily for a
also con
a tax benefit (i.e. as per the PPT,
bo na fide pu rpo se oth er tha n to obt ain
pri nci pal pur pos es for the res tru ctu rin g was to obtain a treaty
on e of the
r~struch1ring thu s qualified as an
ben efi t). As pe r the tax aut hor itie s, the
ian GAAR.
"av oid anc e tra nsa cti on" wit hin the Ca nad
ue bef ore Ca nad ian Co urt wa s wh eth er or not the transaction
Th e iss
Th e Co urt hel d tha t ev~I_uatio_n of
res ult ed in abu se of tre aty pro vis ion s.
or no t the tra nsa cti on res ult s in abu se of tre aty proVIs1ons 1s to
wh eth er
article" of tre aty which is alleged
be see n in lig ht of the int ent of "specific

12
2018 TCC 152.

175
 i
Essay s on Inter natio nal Taxa tion: Liber amic orum - Nish ith Desa Chap ter 7

question
to be abus ed. The Cou rt devo ted cons idera ble atten tion to the
of whe ther "trea ty shop ping " cons titut es an abus e of the treaty.
It noted
Income
that the term is not defin ed in any Can adia n tax treat ies or in the
and 12
Tax Act. The bene ficia l own ersh ip requ irem ent in articles 10, 11
was no
w ere a limi ted anti- abus e or treat y shop ping rule and there
aring in
limi tatio n on bene fits article to prev ent treat y shop ping as appe
eal in
the Cana da-U S treat y. The Cou rt follo wed the Fede ral Cou rt of App
St. M ichael Trus t Corp. v Canada , to conc lude that if the com
13 pany is a
it cannot
resid ent of the othe r cont racti ng state for treat y purp oses , then
by the
misu se or abus e the treat y by claim ing the exem ption prov ided
treat y.
Exa mpl es in OECD Rep ort
OECD
Furt her, usef ul refer ence can be mad e to the exam ple give n in the
test is
repo rt whe re PPT is inap plica ble beca use the obje ct and purp ose
ional
satis fied. In this exam ple, the taxp ayer mak es genu ine addit
25% in
inve stme nt in orde r to incre ase his shar ehol ding from 24 % to
dividend
orde r to avail the conc essio nal with hold ing rate appl icab le to
ct and
inco me. In view of the OECD, this is in acco rdan ce with the obje
ility
purp ose of specific prov ision of treat y whic h arbit raril y fixed eligib
fication
crite ria at 25% and the taxp ayer genu inely met such quali
crite rion.
As agai nst the abov e, in anot her exam ple, the taxp ayer soug
ht to get
ract of
away with the cons truct ion PE thre shol d by split ting the cont
diary.
22 mon ths into 2 cont racts of 11 mon ths each by inter posi ng a subsi
rdance
Such an arra ngem ent is not cons idere d by the OECD to be in acco
with obje ct and purp ose of specific prov ision of treat y.
D is at
A com preh ensi ve discu ssion of all the exam ples give n by 0-EC
Ann exur e 1.
ty and
Imp act of gran dfat heri ng prov ision s in India-Singapore Tax Trea
India-Mauritius Tax Treaty
s and
In Indi an cont ext, the two majo r treat ies viz. with Mauritiu
-ba~ed
Sing apor e have unde rgon e a chan ge purs uant to whic h residence
al gains
taxa tion is mod ified to sour ce base d taxa tion in resp ect of capit
. At
inco me arisi ng from trans fer of shar es of a com pany resid ent in India
s are
the sam e time , to prov ide certa inty to inve stors , trans itory provision
March
intro duce d to gran dfath er shar es whic h have been acqu ired till 31

13 2010 FCA 309 ( CanLII)

Chapter 7 Preventing treaty ab .
use m the context of multilateral instrument
2017 and to provide 500110 •
c d concessional t ax rate for investments a d
trans1ers ma e during A .
. . pn12017 to March 2019. n
An 1nterestmg debate is . w h ether tax
b ene fi t b y claiming that "Iin payers can avail grandfathering
with object and purposavaif g grandfath ering benefit is in accordance
e o treaty ·
reorganization took place b -f ' assuming that the investments or
future tax treaty benefits. e ore 31 March 2017 only to claim potential

7 .3.5 Other issues around application of PPT

(a) Can PPT impact existing structures.,
Once the CTA becomes o era ti
basis i.e. it will apply in re/ect
tax P
t' .
PPT will_ apply on a retroactive
O income which accrues or arises for

th turp~:es ter the CTA enters into effect. It is pertinent to note

a un I e AAR, the PPT does not grandfather an ast
arrangement or st~ctures and the same can still be que~io~ed
under the PPT even if they are in place for many years and have thus
f ar not been challenged.
Also, _a taxpayer which might have hitherto been granted treaty
beneflt may also be qu estioned under PPT rule in relation to a
transaction or arrangement which is concluded hereafter. Even if a
~ransaction 1nay have been concluded in the past but continuing
1n1pact of that transaction can be nullified by questioning the income
accruing in the future years from the very same transaction by the
source country.
(b) Interplay of PPT vis-a-vis treaty LOB/SAAR
To take an example, can PPT be invoked in cases where investments
are made in India through a holding company in Singapore which
satisfies the LOB conditions of the treaty? The answer to this should
be in the affirmative. Merely because the objective criteria of LOB
are satisfied, the same should not be a reason for non-applicability of
PPT. Both the tests may need to be fulfilled simultaneously. Another
view could be that once the LOB criteria is satisfied, the PPT should
not apply as the second limb of PPT could c~~e to rescue if o~e
were to assert that granting of treaty benefits 1s 1n accordance with
the objects and purpose of the treaty. In the same breath,
introduction of PPT does not dilute existing treaty SAAR (such as
beneficial ownership, or applying concession al source taxation rate
1

in respect of interest, royalty, etc._ only to ~rm s-len~h p~yment, etc)

which would need to be satisfied irrespective of satisfaction of PPT.

177
Essays on Intcrnolionul Toxali on : Uber amicorurn - Ni ,;hith Dc,wl Chapter 7

( c) Impact on holding c01npnny stru ctures

In the case of a ho1ding cmnpany whjch is incorporated in a treaty
favourab le jurisdicti on, the holding company would need to fu lfil.I
the PPT requ ire1ncnl by substantiating the fo llowjng aspects;
(j) Substantiating need for having a Reparate entjty ('t;epara.te
entity tes t'); and
(ii ) Substantiating that th e location of entity is selected based on
non-tax co1n1nercia l considerations a.nd tax is, reckoned
merely as an incidental benefit ('location test').
In respect of the separate entity test, useful reference can be-drawn
to the decision of the Supreme Court in the case of Vodafone (supra)
where the Court has acknowledged multiple commercial factors
(such as better corporate governance, mobility of investment,
facilitating an exit route, regulatory reasons, operational efficiencJ ,
hedging political and business risk, etc ) which may drive ta:xpaye-r
to have a separate legal entity for a particular venture or investment.
Substantiating the location test is likely to be a challenge. Onus of
proving that a jurisdiction is selected for non-tax commercial
considerations is on the taxpayer. The exercise primarily requires
taxpayers to demonstrate why a particular location is selected and
why a parent - say from the UK - could not have set up a separate
entity in the UK itself. The challenges get far more exacerbated
when commercial reasons for location are to be provided in respect
of investment holding company or a regional headquarter company.
The following factors as culled out from examples 1 and 2 of the
OECD's discussion draft on treaty eligibility for Non-CIVs and
examples from BEPS Action 6 are relevant in support of choice of
location:
• Availability of skilled, multi-lingual work force;
• Lender and investor familiarity;
• Developed international trade and financial markets;
• Favourable regulatory and legal framework;
• Favourable tax treaty network; especially within the targeted
investment area;
• Availability of directors with knowledge of regional business
practices and applicable regulations;
• Membership of a regional grouping, or, of a common currency area;
• Political stability.

178
 7
Chapter Preventing treaty abuse in the context of multilateral instrument

7 .4 CONC,LUDING REMARKS
The following words 14 of M. Ph··1· · ·
. . -· r. l 1p Baker QC cannot be m'ore apt in
these times:

"There is every re.a:son _to fear that, once the MLI is in force and a large
number of countries ( including ones with tax authorities tha-t do, not
have a reputation f~r pr~dietable interpretation of tax treaties) begin to
apply the PPT_, this will undermine the whole system of tax treaty
bene!7-ts. Put simply, no taxpayer who has given any consideration to
the impact of a tax treaty on its transactions or arrangements 1Ui.ll be
able to rely with any certainty on obtaining the benefits of the ta-£
treaty. n
There is no iota of doubt that taxpayers will need to consider their
existing structures and future transactions keeping PPT into perspective.
The interpretation of various elements of the PPT may not be easy in
practice. Whilst there is limited guidance available in the OECD Reports
(including examples on whether PPT can apply to a given fact pattern),
the same might merely carry a persuasive value in the real world. A far
greater analysis ought to be made as far as the 0bject and Purpose· test0

of tax treaty is concerned as it provides for a significant carve out from

the rigors of the PPT.
One hopes that the tax authorities adopt a pragmatic and reasonable
approach in application of MLt PPT in particular, which in my view
should be applied only to abusive or highly aggressive/ contrived
arrangements. Also, the 'choice principle' should be respected and should
not be prone to PPT (for example, conducting business in an LLP vis-a-
vis a company, acquiring an asset on lease vis-a-vis ou1:rlght pur~hase,
funding by way of debt rather than equity, etc. are all business choices of
a taxpayer and should not be subjected to scrutiny under PPT).
Clearly, the road ahead seems quite enticin~ ~~ l~ts to le~gs . in
store for taxpayers, tax authorities an~ the Jud1oary. As Alvm Tofil.er
quotes, "The illiterate of the 21 81 century will not be th~e who cannot read .and
write, but those who cannot learn, unlearn, and relearn.

14
- Measures to Prevent Base Erosion and
The Multilateral Convention to lm.plement T ax T rea ty Related
Profit Shifting. British Tax Review, 2017 • page 283 ·

179