The provisions of the amended protocol will apply in India on income derived beginning April 1, 2027.

The Indian Express - India has amended its tax treaty with Sri Lanka to tighten loopholes in double taxation avoidance and to curb revenue leakage by preventing treaty abuse. The intention for amending the pact has been to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance through treaty-shopping arrangements.

The amended protocol between the two countries was brought into force on June 19 this year and has now been notified by the Ministry of Finance.

The provisions of the amended protocol will apply in India on income derived beginning April 1, 2027.

The amended treaty between the two countries has included the Principal Purpose Test (PPT). An anti-avoidance tool, the PPT ensures denial of benefits under a double taxation avoidance agreement (DTAA), where it is reasonable to conclude that one of the principal purposes of an arrangement or transaction was to obtain a benefit, directly or indirectly, under a treaty unless the granting of the benefit was in accordance with the object and purpose of the treaty.

Tax authorities will now be empowered to examine the commercial intent behind an investment structure and deny treaty benefits if obtaining a tax advantage is considered one of its principal purposes, unless the arrangement is consistent with the treaty’s object and purpose, experts said.

The PPT is intended to ensure that DTAAs apply in accordance with the objects and purpose for which they were entered into, that is, to provide benefits in respect of bona fide exchange of goods and services, and movement of capital and persons.

Richa Sawhney, Partner, Grant Thornton Bharat said this change in the preamble will ensure that the treaty will not be used to grant benefit in cases of double non-taxation and treaty shopping along with the introduction of the PPT, which was earlier not present in this treaty.

“These changes bring in two significant OECD MLI (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,” Sawhney said.

By inserting the internationally recognised Principal Purpose Test, India has armed tax authorities with the ability to deny treaty benefits where structures are designed primarily to secure lower tax burdens rather than facilitate real economic activity, said Amit Agarwal, Senior Partner, Nangia & Co LLP.

“For investors, the amendment marks a shift from certainty to greater subjectivity in claiming treaty benefits. Earlier, investors could largely rely on meeting objective legal requirements — such as tax residence, beneficial ownership and prescribed documentation — to access treaty relief,” Agarwal said.

The ‘Multilateral Convention to implement tax treaty related provisions to prevent Base Erosion and Profit Shifting’ (MLI) entered into force for India on October 1, 2019. While the PPT is included in most of India’s DTAAs through the MLI, it is part of some other DTAAs through bilateral processes for countries such as Chile, Iran, Hong Kong, and China.

In January 2025, the Central Board of Direct Taxes had issued a circular on PPT stating that it will apply prospectively and the gains on transfer of shares acquired by residents of Mauritius, Cyprus, and Singapore in Indian companies prior to April 2017 have been grandfathered and will remain outside the purview of the PPT.