PPT vs. GAAR | A classic anti-abuse dilemma!

The Principal Purpose Test (PPT) under certain tax treaties allows denial of treaty benefits if it is reasonable to conclude that ‘one of the principal purposes’ of an arrangement or transaction was to obtain that benefit, unless granting such benefit aligns with the object and purpose of the relevant provision of the treaty.

The domestic counterpart under the Income-tax Act 1961, the GAAR, sets a stricter threshold:

• The ‘main purpose’ of the arrangement (or any step-in or part thereof) must be to obtain a tax benefit and the arrangement must also satisfy one of the tainted element tests [Section 96(1)]; and
• GAAR cannot be invoked unilaterally by the AO. It requires a multi-tiered approval, upto the level of the Approving Panel chaired by a serving or retired High Court judge [Section 144BA].

Given these safeguards and the higher threshold, GAAR may at times be favourable to the assessee vis-a-vis PPT clause under the treaty.

This brings section 90(2) into the picture, which states that the provisions of the “Act” shall apply to an assessee if they are “more beneficial” than the provisions of the tax treaty.

A critical question: If treaty benefits are denied solely by invoking the PPT (without initiating GAAR proceedings) can it be argued that the assessee has been deprived of the more beneficial route under GAAR?

A likely counter could be that once PPT, being a non-obstante provision under the treaty is invoked, treaty benefits will not be available at all and therefore, the question of applicability of section 90(2) will not arise.

However, this misses a crucial nuance: Who decides whether anti-abuse provisions should be invoked in the first place? Under PPT, the AO may do so unilaterally while under GAAR, there are procedural safeguards. The very existence of these safeguards under GAAR can be considered to be “more beneficial” to the assessee for the purposes of section 90(2).

Moreover, while section 90(2A) overrides section 90(2) and states that GAAR ‘will apply’ even if ‘it is not beneficial’ to the assessee, it does not say that GAAR ‘will not apply’ if ‘it is beneficial’ to the assessee.

This highlights various legal dilemmas: Can treaty benefit be denied solely through PPT while bypassing the rigorous checks under GAAR? Can PPT be invoked when GAAR is inapplicable, for instance when tax benefit is below Rs. 3 crores? Or whether GAAR and PPT operate independently and need to be applied independently without encroaching upon each other’s domain?

A fascinating area, ripe for judicial consideration.

#GAAR #PPT #Incometax