The revised protocol affecting the tax treaty between India and Sri Lanka is set to take effect from April 1, 2027, regarding income generated thereafter. As reported by The Indian Express, India has updated its tax agreement with Sri Lanka to address gaps that previously enabled double taxation avoidance and to prevent revenue loss through treaty misuse. The primary objective of these amendments is to eliminate double taxation while ensuring that no opportunities arise for non-taxation or reduced taxation due to tax evasion tactics or treaty-shopping practices.
This updated protocol was officially enacted on June 19 of this year and has now been officially communicated by the Ministry of Finance. Among its key features is the introduction of the Principal Purpose Test (PPT), an anti-abuse mechanism designed to deny benefits under the double taxation avoidance agreement (DTAA) if it can be reasonably inferred that one of the main purposes of a transaction or arrangement is to secure a benefit from the treaty, unless such benefits align with the treaty’s intent and objectives.
Tax authorities in India will now have the authority to assess the economic rationale behind investment structures and can withhold treaty benefits if one of the main intentions of that structure is to gain a tax advantage, except when the arrangement aligns with the treaty’s intended purpose, as noted by industry experts.
The PPT aims to ensure that DTAAs are applied in line with their original goals, which include facilitating legitimate exchanges of goods and services, as well as the movement of capital and individuals. Richa Sawhney, a partner at Grant Thornton Bharat, emphasized that the amendments to the preamble will prevent the treaty from being exploited for cases of double non-taxation and treaty shopping. The introduction of the PPT is a significant addition not previously present in this treaty.
“These modifications represent two important changes mandated by the OECD Multilateral Instrument (MLI). Together, they signal a clear intention that treaty benefits are intended only for arrangements with genuine commercial substance and business purpose. This makes it increasingly essential for taxpayers to provide evidence supporting the commercial rationale of their structures,” Sawhney remarked.
Amit Agarwal, Senior Partner at Nangia & Co LLP, stated that by incorporating the internationally recognized Principal Purpose Test, Indian tax authorities are now equipped to deny treaty benefits when structures are primarily designed to achieve lower tax liabilities rather than to promote genuine economic activities. He noted that this amendment signifies a shift for investors from a previously objective framework to a more subjective approach when claiming treaty benefits.
Previously, investors could generally rely on meeting specific legal criteria—such as tax residency, beneficial ownership, and required documentation—to secure treaty relief. The Multilateral Convention aimed at implementing tax treaty provisions to prevent Base Erosion and Profit Shifting (MLI) came into effect for India on October 1, 2019. While the PPT is included in most of India’s DTAAs via the MLI, it has also been incorporated into certain other DTAAs through bilateral negotiations with countries like Chile, Iran, Hong Kong, and China.
In January 2025, the Central Board of Direct Taxes issued a circular affirming that the PPT will apply prospectively. Gains from the transfer of shares held by residents of Mauritius, Cyprus, and Singapore in Indian companies prior to April 2017 will be exempt from the PPT provisions.
