Invoke either GAAR or principal purpose test: Asifma tells Centre

Asia Securities Industry & Financial Markets Association (Asifma), an independent regional trade association with over 100 member firms, has asked the government to ensure that taxpayers were not subjected to both the principal purpose test (PPT) and the general anti-avoidance rule (GAAR).

The principal purpose test is an anti-abuse provision, which is part of a multilateral instrument (MLI) and has been adopted by more than 70 countries, including India. 

According to the industry body, taxpayers subjected to the PPT and GAAR provisions might have to go through GAAR twice —first under the treaty and then under the domestic law. “It should be clarified that only one of the two should be invoked,” Asifma said.

One way to address treaty abuse is to insert a PPT rule in double taxation avoidance agreements (DTAAs). The PPT rule and the GAAR provisions are similar in nature. While GAAR provisions are triggered where the main purpose of an arrangement is to obtain tax benefit, the PPT rule is applicable where a principal purpose is to obtain benefits of a DTAA. If both GAAR and PPT rule are applied, the taxpayer will not be able to reap benefits of the DTAA.

The Indian tax laws provide safeguards and outline how GAAR should be applied. However, there is no guidance on how the PPT rule will be applied by the tax authorities and what constitutes ‘principal purpose’.

“While various terms of the PPT rule have been defined and examples have been illustrated, the explanation provided is broad and subjective and does not offer conclusive guidance to taxpayers,” Asifma said.

According to Asifma, the way the PPT rule is to be invoked needs to be specified. For instance, a minimum threshold should be provided for invoking the PPT rule, seeking approvals of the relevant authorities, etc.

“Given that PPT and GAAR are similar in nature, the guidance provided in respect of GAAR should also be applicable for PPT. Arrangements and transactions undertaken before the PPT rule is made effective should be grandfathered,” Asifma added.

According to a recent report by PwC, the PPT rule could be broader in its ambit than GAAR under the Income Tax Act, since GAAR is only triggered if the main purpose of an arrangement is to obtain a tax benefit. Furthermore, in order for GAAR to be triggered, one of the other ‘tainted’ elements also needs to be satisfied. These elements include creation of rights or obligations that are not at an arm’s length, abuse of the IT Act and lack of commercial substance or bona fides.

“It is unlikely for GAAR to apply if the PPT rule is met. It is yet to be seen how the interplay between GAAR and the PPT rule will pan out in the treaties,” said PwC.

The domestic GAAR and MLI have dissuaded foreign portfolio investors (FPIs) from shifting to European jurisdictions such as France, Spain and the Netherlands as envisaged earlier.

Until April 1 this year, FPIs took the Mauritius, Singapore, and Cyprus route to pool money from investors across the globe and invest in India. The earlier treaties signed by India (amended in 2016) allowed for taxation of capital gains earned in India to be subject to tax only in the other country. Since these countries did not charge tax on capital gains, FPIs remained out of the net.