The Delhi Bench of the income tax appellate tribunal (ITAT) has allowed a Luxembourg-based taxpayer, that satisfied the provisions of the principal purpose test (PPT), to avail of benefits under the India-Luxembourg tax treaty.

PPT provisions provide that treaty benefits will not be granted if one of the primary purposes of a transaction or arrangement is to obtain those benefits.

The tribunal referred to the Delhi High Court decision in the case of Tiger Global and held that the tax residency certificate (TRC) issued by a competent authority has to be accepted.

The case

The taxpayer was a category II foreign portfolio investor incorporated as a limited liability company in Luxembourg. The FPI was the wholly owned subsidiary of a Cayman based company. The FPI earned an income from its investment in Indian AIFs, securitisation trusts, sale of debentures issued by Indian companies and interest received from debt investments.

In its tax return for assessment year 2021-22, the FPI claimed the benefit of the India-Luxembourg treaty in respect of interest income, business income, and capital gains. The tax officer denied the treaty benefits, citing treaty shopping and insufficient commercial substance. It was alleged that the residents of Cayman Islands — and not the taxpayer — was the beneficial owner of the income.

Taxpayer’s contention

The taxpayer was incorporated in Luxembourg in 2015, well before the MLI came into effect. It is a board managed company with its legal seat and registered office in Luxembourg. The taxpayer operates as a step-down subsidiary of a Cayman Islands-based special purpose vehicle for pooling funds from various investors.

The taxpayer made its first investments in India in 2018-19 however, 86 per cent of its investments are in jurisdictions outside India. The taxpayer also filed tax returns and paid tax in Luxembourg on its worldwide income.

Expert take

The decision reiterates the importance of having commercial justification for choosing a jurisdiction for Indian investments, said experts.

“The Tribunal decision examines the common master-feeder structures wherein investor money is pooled in one jurisdiction and investments across jurisdictions are made through the feeder fund. While the Cayman Islands does not have a tax treaty with India, it is often a choice of jurisdiction for several investors for commercial reasons. The findings of the tribunal should provide guidance in relation to PPT in future matters as well,” said Ipsita Agarwalla, Leader and Parul Jain, Partner, Nishith Desai Associates, in a note.

“This decision underscores the need for a balanced approach in applying anti-abuse provisions, ensuring that legitimate business arrangements are not adversely impacted by aggressive tax positions,” said a note by KPMG India.