Tax Treaty Benefit Rules in India Evolve for Foreign Investors

India, like various other jurisdictions, follows source-based taxation for non-residents. While principles of residence-based taxation largely rely on the territorial laws, source-based taxation is where the taxation laws of two jurisdictions lock horns. This is where the role of tax treaties gains relevance. Tax treaties are bilateral arrangements entered into for avoiding double taxation of the same income and for the allocation of taxation rights between the source and residence jurisdictions. These bilateral agreements are largely based on the principles framed by the international organizations such as the Organisation for Economic Co-operation and Development and the United Nations .

Indian tax law enables a person who is resident of a country with which India has a tax treaty, to be taxed as per the beneficial provisions of the applicable tax treaty. However, the application of the tax treaty is not automatic. With the evolving tax laws, introduction of general anti-avoidance rules under Indian tax law as well as tax treaties and the jurisprudence, the eligibility to claim the tax treaty benefit is subject to satisfaction of certain objective as well as substantive criterion.

Objective Conditions

Under the Indian tax laws, the key pre-requisite to claim the tax treaty benefit is that the taxpayer should hold a valid tax residency certificate (TRC) issued by its home jurisdiction for the relevant year. This is to demonstrate that the taxpayer is a tax resident of its home jurisdiction. If the TRC does not contain the prescribed information such as taxpayer’s legal status, tax identification number (TIN) or unique identification number, period of TRC, etc., the taxpayer is required to submit a self-declaration in Form 10F to report such information with the tax authorities.

In addition to the above, the taxpayer should satisfy the objective thresholds (if any) under the applicable tax treaty. For instance, in the context of the India-Singapore tax treaty, if an income is taxed in Singapore to the extent of income actually received in Singapore, the tax treaty benefit in India is also limited to the amount of income remitted to Singapore.

Substantive Conditions

Liable to Tax
For a non-resident to avail benefits under the tax treaty, it is essential that such non-resident is “liable to tax” in its home jurisdiction either as per their local laws or by reason of its residence or domicile or place of management or any other similar criteria, as required by the applicable tax treaty. Applicability of this test in the context of a fiscally transparent entity has been a subject matter of debate. Certain tax treaties (such as India-US and India-UK tax treaties) provide that a fiscally transparent partnership or trust is treated as tax resident of its home jurisdiction, if the income is taxed in the home jurisdiction either in the hands of such partnership or trust or its partners or beneficiaries, as the case may be. Having said that, in other structures of a fiscally transparent entity, the eligibility to claim a tax treaty benefit is not straight forward. While OECD supports the view that a pass-through entity can look through to its investors for purposes of applying the respective treaty benefits, India (not an OECD member) has made a reservation and stated that tax treaty benefit should be allowed only if the income is derived by a person which is a resident of the treaty partner jurisdiction. In certain cases, the Indian courts have however adopted a pragmatic approach and accorded tax treaty benefit to fiscally transparent entities where the investors / beneficiaries were liable to tax in the jurisdiction of the investing entity. As a result, the eligibility to claim a tax treaty benefit needs to be assessed based on the peculiar facts of each such entity based on the principles of “liable to tax” under the applicable laws.

Beneficial Ownership
The concept of beneficial ownership is primarily relevant in the context of dividends, interest, royalties, and fees for technical services. Beneficial ownership demands a substance over form approach and emphasizes actual control and economic rights over the income, in addition to the legal ownership. Based on the principles in OECD and UN Commentaries, the beneficial ownership test requires the recipient having an unconstrained right to enjoy the income it earns with there being no obligation on such recipient to pass on the income it earns to any other person. Though not technically applicable, the Indian tax authorities often invoke the beneficial ownership concept while adjudicating the capital gains tax exemption claimed in India under the tax treaties. It is therefore essential for the investing entities to demonstrate that the board of such entity / fund has the exclusive right to apply or distribute the income, at its discretion.

Prevention of Tax Treaty Abuse

Originally, the Indian tax law provided for specific anti-avoidance rules (SAAR) to deal with tax avoidance in specific circumstances. However, effective from April 1, 2017, India has introduced the provisions of General Anti Avoidance Rules (GAAR) under the Indian tax laws itself. GAAR is targeted at arrangements whose main purpose is to obtain a tax benefit and which either lacks commercial substance or results in misuse or abuse of tax provisions or creates rights or obligations that are not ordinarily created in arm’s length transactions or entered into by means or in a manner not ordinarily employed for a bona fide purpose. Arrangements of this nature are treated as an “impermissible avoidance arrangement” and the Indian tax authorities are empowered to disregard or recharacterize any step in such arrangement or disregard the entire arrangement and levy tax based on substance over form (including denial of tax treaty benefit).

Similarly, the OECD along with the G20 launched certain action plans to address Base Erosion and Profit Shifting (BEPS) by the multinational companies. To implement these measures, BEPS Action Plan 15 introduced the multi-lateral instrument (MLI). For the MLI to be effective, countries which have a tax treaty in place are required to sign the MLI and notify such tax treaty as a covered tax agreement (CTA). Countries that notified the tax treaty as CTA are required to implement the following minimum standards:

1. An express statement stating a common intention for eliminating double taxation without creating opportunities for tax evasion or avoidance which result in no tax or reduced tax; and
2. Implementation of either of the following:
a. Limitation of benefit (LOB) clause: To restrict the tax treaty benefit to “qualified persons” i.e., persons having sufficient presence in the relevant jurisdiction;
b. Principal purpose test (PPT): To deny treaty benefit if any principal purpose of an arrangement or a structure is to claim such a benefit, unless it is in accordance with the object and purpose of the relevant provisions of the tax treaty; or
c. A combination of LOB and PPT, i.e., inclusion of PPT with a simplified or detailed LOB clause

Pursuant to the above, the tax treaties between India and various other countries (for instance, Singapore, Netherlands, Japan, United Kingdom, Luxembourg, United Arab Emirates) have been notified as a CTA which now includes PPT as a minimum standard. India-Mauritius tax treaty is not a CTA, but a separate protocol has been executed to include PPT in the tax treaty, which is yet to be made effective.

Interestingly, GAAR grandfathers the investments made prior to April 1, 2017. Similarly, the Central Board of Direct Taxes (CBDT) (see Circular No. 1 of 2025 (Jan. 21, 2025) has clarified that bilateral commitments made by India in the form of grandfathering provisions under its tax treaties with countries, such as Cyprus, Mauritius and Singapore, shall remain outside the purview of the PPT.

Subject to grandfathering provisions, GAAR and PPT require the taxpayer to demonstrate that a particular structure or arrangement is backed by sound commercial rationale and that the taxpayer has adequate substance in its home jurisdiction.

Judicial Overview

The Indian courts have been cognizant of the evolving landscape of investment structures, the introduction of GAAR, the PPT, andinternational developments while adjudicating the tax treaty disputes.

In one of the disputes, the Azadi Bachao Andalon case, the Indian Supreme Court upheld the validity of CBDT Circular no. 789 of 2000 that was challenged. The Circular clarified that a TRC issued by Mauritian Authorities would constitute sufficient evidence for residential status and beneficial ownership for application of the India-Mauritius tax treaty.

In the Blackstone Capital Partners case, relying on the Azadi Bachao Andolan ruling, the Delhi High Court upheld the sufficiency of the TRC for claiming benefit under the India-Singapore tax treaty and ruled that tax authorities cannot pierce the veil to go beyond the TRC.

In yet another case, the tax authorities denied the India-Mauritius tax treaty benefit to Tiger Global International II Holdings (Tiger Global) by claiming that Tiger Global is not the beneficial owner of the underlying investments. However, the Delhi High Court held that the beneficial ownership test could only be invoked if the asset is held in trust with an obligation of passing on the income to the beneficial owner. The court noted that the tax authorities could not demonstrate that the structure was a sham or colourable device and hence, granted the India-Mauritius tax treaty benefit.

However, the position remains unsettled with the tax authorities having challenged these orders before the Supreme Court and is now pending for adjudication.

Separately, the Delhi Bench of Income Tax Appellate Tribunal (Tribunal) adjudicated on the applicability of the PPT under the India-Luxembourg tax treaty in the SC Lowy P.I. (LUX) S.A.R.L case. The tax officer challenged the India-Luxembourg tax treaty benefit claimed on the income earned from Indian investments by alleging that the investing entity was set up in Luxembourg primarily to claim such a benefit. However, the Tribunal noted that the Luxembourg entity was set up to raise funds and invest globally (as evident from the fact that 86% of the total investments were made outside India) and had also been subject to tax in Luxembourg and consequentially granted the India-Luxembourg tax treaty benefit.

In certain other rulings, the courts have recognized the commercial realities that a wholly owned subsidiary corporation is expected to be controlled by its parent, and the subsidiary is not considered a conduit of the parent unless the board of directors (BOD) has completely divulged their powers in favor of the parent. Similarly, in a case involving the tax treaty benefit eligibility of an investment fund, the courts have acknowledged that the substance in such funds should be commensurate with its functions, and the fund cannot be treated at par with an operating company.

Key Takeaways

Eligibility to claim the tax treaty benefit has evolved significantly. A TRC on a standalone basis may not be sufficient and depending on the facts and circumstances, a foreign entity / offshore investment fund could be required to demonstrate the commercial rationale for the underlying structure and adequate substance in the home jurisdiction. Structures involving parent / investor being situated in a third jurisdiction should have robust commercial explanation for selecting the intermediary jurisdiction. Similarly, tax treaty exemption being claimed in an indirect transfer scenario could require the taxpayers to justify the rationale for a two-tiered structure. Accordingly, it becomes imperative to undertake a threadbare analysis considering the shareholding structure, business plan, profile of the directors / investment committee (including their tax residency, skill, experience, etc.), bank account signatories, arrangement with Indian entities, conduct of BOD, and whether all of these are documented appropriately (including in the minutes of BOD meeting / BOD resolutions, investment agreements and filings in India and home jurisdiction).

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Rahul Jain is a partner and Akshara Shukla is a principal associate in the Direct Tax Practice group at Khaitan & Co in Mumbai.