India tightens Sri Lanka tax treaty with anti-abuse rule
India has amended its Double Taxation Avoidance Agreement (DTAA) with Sri Lanka through a bilateral protocol, inserting a Principal Purpose Test (PPT) provision.
The PPT allows tax authorities to deny treaty benefits (such as reduced withholding tax rates) to an arrangement or transaction if obtaining that tax benefit was one of its principal purposes, unless granting the benefit would be in accordance with the treaty's object and purpose.
The amendment also updates the treaty's preamble to explicitly state that the agreement is not intended to create opportunities for non-taxation or reduced taxation through tax evasion or avoidance, including treaty-shopping arrangements.
The change takes effect for income arising from FY28 onward, giving businesses and investors a transition window before enforcement begins.
The move aligns the India-Sri Lanka DTAA with global minimum standards on treaty abuse, since Sri Lanka is not a signatory to the OECD/G20 Multilateral Instrument (MLI) and therefore required a standalone bilateral protocol instead of automatic multilateral coverage.
Double Taxation Avoidance Agreement (DTAA)
A DTAA is a bilateral tax treaty between two countries designed to prevent the same income from being taxed twice — once in the country where it is earned (source) and again in the country of the taxpayer's residence. India has DTAAs with over 90 countries, using either the exemption method or the tax-credit method to grant relief. The existing India-Sri Lanka DTAA was originally signed on 22 January 2013 and entered into force on 22 October 2013.
Key Details
- DTAAs typically cover income heads like business profits, dividends, interest, royalties, capital gains, and fees for technical services, prescribing capped withholding tax rates.
- India's tax treaty network is administered by the Central Board of Direct Taxes (CBDT) under the Ministry of Finance.
The Sri Lanka protocol modifies an existing 2013 DTAA rather than creating a new treaty, illustrating how existing agreements are periodically updated to close loopholes without renegotiating the entire treaty.
BEPS Action 6 and the Principal Purpose Test (PPT)
The Principal Purpose Test is an anti-abuse rule developed under Action 6 ("Preventing Treaty Abuse") of the OECD/G20 Base Erosion and Profit Shifting (BEPS) Project, launched in 2013 to address tax planning strategies that exploit gaps and mismatches in international tax rules. PPT is one of the BEPS "minimum standards" that all Inclusive Framework members, including India and Sri Lanka, committed to implementing to counter treaty shopping — where a resident of a third country routes investments through a treaty-favourable jurisdiction to access lower withholding rates.
Key Details
- BEPS Action 6 offers three ways to meet the minimum standard: PPT alone, PPT plus a simplified/detailed Limitation of Benefits (LOB) clause, or a detailed LOB clause plus anti-conduit rules.
- India previously renegotiated its DTAAs with Mauritius, Singapore, and Cyprus (2016 amendments) to introduce source-based taxation of capital gains and LOB provisions, targeting the same treaty-shopping concern via a different mechanism.
- The CBDT has separately issued guidance clarifying the application of PPT across India's DTAA network to reduce interpretational disputes.
Because Sri Lanka has not signed the MLI (the instrument that allows BEPS minimum standards to be adopted across multiple treaties simultaneously), India had to negotiate the PPT bilaterally through this protocol — making the Sri Lanka case a good example of the MLI's coverage limits.
Multilateral Instrument (MLI) and Treaty Shopping
The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (MLI), developed under BEPS Action 15, allows countries to modify multiple bilateral tax treaties simultaneously to incorporate BEPS-related measures like the PPT, without renegotiating each treaty individually. India ratified the MLI and it entered into force for India on 1 October 2019, modifying dozens of India's treaties with signatory countries in one step.
Key Details
- Treaty shopping refers to structuring investments through a jurisdiction solely (or principally) to access more favourable tax treaty terms not otherwise available to the ultimate investor.
- Non-MLI signatory countries (like Sri Lanka) require bilateral protocols, which take longer to negotiate and ratify than MLI-covered treaties.
The India-Sri Lanka protocol shows the "manual" route to BEPS compliance that the MLI was designed to shortcut — relevant for questions comparing multilateral versus bilateral tools in international tax cooperation.
- Existing India-Sri Lanka DTAA: signed 22 January 2013, entered into force 22 October 2013.
- New PPT provision effective for income from FY28 onward.
- PPT introduced under BEPS Action 6 (OECD/G20 BEPS Project, launched 2013).
- Sri Lanka is not an MLI signatory, necessitating a bilateral protocol rather than MLI-based amendment.
- India's MLI entered into force on 1 October 2019.
- India previously added anti-abuse/LOB provisions to DTAAs with Mauritius, Singapore, and Cyprus in 2016.