India and Sri Lanka have significantly strengthened their Double Taxation Avoidance Agreement (DTAA) by introducing robust provisions designed to combat tax evasion and "treaty shopping." The amendment, formally notified by the finance ministry, aims to ensure that the bilateral tax pact is used solely to prevent double taxation, not to facilitate tax avoidance or unintended benefits.
Introducing the Principal Purpose Test (PPT)
A cornerstone of the revised DTAA is the inclusion of the Principal Purpose Test (PPT). This anti-avoidance instrument ensures that any transaction or arrangement seeking tax benefits under the treaty must have a genuine commercial or business rationale, rather than solely aiming to gain tax advantages. If obtaining a tax benefit is determined to be one of the principal purposes of a transaction, that benefit will not be granted, unless it aligns with the core objectives and provisions of the DTAA.
Revised Preamble and International Alignment
The Preamble to the treaty has been updated to explicitly state its intention: “to eliminate double taxation... 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).”
Experts, such as Richa Sawhney, Partner at Grant Thornton Bharat, highlight that these amendments bring the India-Sri Lanka DTAA in line with contemporary international tax norms. The changes incorporate key aspects mandated by the OECD Multilateral Instrument (MLI), signaling a clear message that treaty relief is intended exclusively for arrangements underpinned by genuine commercial substance and purpose.
Effective Date and Impact
These enhanced anti-avoidance measures will apply to income generated from April 1, 2027, onwards. It is important to note that the amendments do not alter any existing tax rates within the agreement. The original India-Sri Lanka DTAA was signed on January 22, 2013, and came into force on October 22, 2013. The protocol for these latest amendments received Union Cabinet approval in February 2022, was signed in December 2024, and became effective on June 19 of the current year.