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CA Final · Direct Tax Laws & International Taxation · Fundamentals of BEPS

A company resident in a low-tax country holds shares in an Indian company. It was interposed in the holding chain shortly before a large dividend was declared, only so that a reduced withholding rate in the treaty could be claimed. The treaty has been modified by the Multilateral Instrument to include the principal purpose test (BEPS Action 6). How will the test apply?

Treaty benefit can be denied because the test asks whether obtaining the benefit was one of the principal purposes of the arrangement, not the sole purpose. Relief survives only if the taxpayer shows that granting it accords with the treaty's object and purpose. Mere residence or a registered office is not enough.

  1. AThe benefit is denied if obtaining it was one of the principal purposes of the arrangement, unless granting it is in accordance with the object and purpose of the treatyCorrect
  2. BThe benefit is denied only if obtaining it was the sole purpose of the arrangement
  3. CThe benefit is always allowed if the company is a tax resident of the treaty partner
  4. DThe benefit is allowed if the company has a registered office in the treaty country, irrespective of purpose

Explanation

The principal purpose test denies a treaty benefit if it is reasonable to conclude that obtaining it was one of the principal purposes of an arrangement or transaction. The exception is where granting the benefit would be in accordance with the object and purpose of the treaty provisions. The test is not limited to sole purpose, and residence or a registered office alone does not defeat it.

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