Principal Purpose Test: Treaty Shopping Arrangements/ Double Taxation Avoidance Agreement (DTAA)

Why in News ? India has signed a protocol amending its tax treaty with Mauritius with an aim to plug treaty abuse for tax evasion and avoidance.
•India and Mauritius has recently signed a protocol at Port Louis, amending the Double Taxation Avoidance Agreement (DTAA) between the two nations.
•The amended pact includes the Principal Purpose Test (PPT), which is in line with the global efforts against treaty abuse, particularly under the BEPS (Base Erosion and Profit Shifting) framework.
What is Principal Purpose Test?
•The PPT essentially implies that the tax benefits under the treaty will not be applicable if it is established that obtaining that duty benefit was the principal purpose of any transaction or arrangement.
•The two nations have also amended the preamble of the treaty to incorporate the thrust on tax avoidance and evasion.
•The earlier objective of “mutual trade and investment” has now been replaced with an intent to “eliminate double taxation” without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance including through “treaty shopping arrangements

What is The Base Erosion and Profit Shifting (BEPS) ?
•BEPS refers to tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity. This practice erodes the tax base of countries where the economic activity actually takes place.
• The framework is an initiative developed by the Organisation for Economic Co-operation and Development (OECD) and the G20 countries to address tax avoidance strategies used by multinational companies.
What is Treaty Shopping Arrangements?
• It refers to a practice where a taxpayer from one country utilizes tax treaties between other countries to reduce their overall tax liability.
• This typically involves structuring transactions or business operations in a way that takes advantage of more favorable tax treatment available under the tax treaties of other jurisdictions.