India-Sri Lanka Tax Treaty Amended: Anti-Avoidance Focus
By Business Desk
India and Sri Lanka amend tax treaty with Principal Purpose Test (PPT) to combat treaty abuse and revenue leakage, aligning with global anti-avoidance standards.
The recent amendment to the tax treaty between India and Sri Lanka, which came into force on June 19, 2026, and will apply to income derived starting April 1, 2027, marks a significant structural shift in India’s approach to international taxation. This move by the Ministry of Finance is explicitly designed to counter treaty abuse and revenue leakage, moving beyond merely avoiding double taxation to actively prevent opportunities for non-taxation or reduced taxation through treaty-shopping arrangements.
At the core of this revised protocol is the introduction of the Principal Purpose Test (PPT), a robust anti-avoidance mechanism. The PPT empowers tax authorities to deny benefits under a Double Taxation Avoidance Agreement (DTAA) if it is reasonably determined that a primary objective of an arrangement or transaction was to secure a treaty benefit, either directly or indirectly. Crucially, such benefits will only be granted if they align with the DTAA’s overarching objective and purpose, signaling a move towards scrutinizing the genuine commercial intent behind investment structures rather than solely their legal form.
This amendment is not an isolated incident but rather indicative of a broader, systemic alignment with global tax standards. Experts like Richa Sawhney from Grant Thornton Bharat and Amit Agarwal from Nangia & Co LLP confirm that these changes, alongside modifications to the treaty’s preamble, bring the India-Sri Lanka DTAA in line with mandates from the Organisation for Economic Co-operation and Development’s (OECD) Multilateral Instrument (MLI). This framework ensures that treaty relief is exclusively reserved for arrangements possessing authentic commercial substance and a legitimate business purpose.
The MLI itself came into force for India on October 1, 2019, incorporating the PPT into a majority of India’s DTAAs. This evolution underscores a fundamental shift for investors, who can no longer rely solely on objective legal compliance but must now proactively substantiate the commercial rationale underpinning their financial structures. A Central Board of Direct Taxes circular from January 2025 further clarified the prospective application of the PPT, while notably grandfathering gains on the transfer of shares in Indian companies acquired by residents of Mauritius, Cyprus, and Singapore prior to April 2017.
This pattern suggests that tax authorities are systematically closing avenues for arbitrage, pushing for greater transparency and genuine economic activity as the basis for tax benefits. The India-Sri Lanka protocol serves as a concrete example of how jurisdictions are adapting their bilateral agreements to reflect the spirit of international anti-avoidance efforts, ensuring that tax treaties facilitate legitimate trade and investment without inadvertently enabling aggressive tax planning. The long-term implication is a more rigorous and less permissive global tax environment, demanding greater integrity from cross-border financial arrangements.