India strengthens DTAA with Sri Lanka to plug anti avoidance loopholes

 India has tightened its tax treaty with Sri Lanka plugging anti avoidance related loopholes and introducing provisions to deny benefits to transactions that were structure only with the tax pact in mind and treaty shopping.   To this effect, the finance ministry notified the Protocol amending the Agreement between the India and Sri Lanka for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income.   The amendment has introduced the Principal Purpose Test into the treaty to ensure that the aim of the transaction is not to only get tax benefits and is considered an important anti avoidance instrument in tax treaties.   The Preamble to the treaty now includes a provision stating that the intention is “to eliminate double taxation with respect to the taxes covered by this Agreement without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty shopping arrangements aimed at obtaining reliefs provided in this Agreement for the indirect benefit of residents of third states).”   Another significant provision that has been introduced states that “a benefit under this Agreement shall not be granted in respect of an item of income 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 this Agreement.”   Experts note that the amendments now bring the treaty in line with international norms.   Richa Sawhney, Partner, Grant Thornton Bharat said the change in the Preamble specifically brings in that treaty will not be used to grant benefit in cases of double non taxation and treaty shopping. It also brings in the Principal Purpose Test in the treaty, an important anti avoidance tool, which was earlier not present in this treaty, adding that these changes bring in two significant OECD Multilateral Instrument mandated changes in this treaty.   “Read together, these changes send a clear signal that treaty relief is intended only for arrangements supported by genuine commercial substance and business purpose, making it increasingly important for taxpayers to be able to substantiate the commercial rationale underlying their structures,” she said.   The changes will be effective and apply on income from April 1, 2027. The treaty does not change any tax rates.   The India- Sri Lanka Double Taxation Avoidance Agreement was signed on January 22, 2013 and entered into force on October 22, 2013. The Union Cabinet had in February 2022 approved signing and ratification of the Protocol amending the tax treaty to update the preamble text and include the Principal Purpose Test. It was then signed in December 2024 and came into force from June 19 of this year.