The Principal Purpose Test is a general anti-abuse rule written into a Double Taxation Avoidance Agreement (DTAA). It says that a benefit under the treaty - a lower withholding rate, an exemption from capital gains tax - shall not be granted if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was ONE OF the principal purposes of the arrangement or transaction that produced it. The benefit is still allowed if it is established that granting it would be in accordance with the object and purpose of the treaty. The rule was designed by the OECD/G20 under Action 6 of the Base Erosion and Profit Shifting (BEPS) project to stop 'treaty shopping' - routing investment through a company in a treaty country, often a shell with no real business there, only to claim that treaty's benefits. It is part of the BEPS minimum standard on treaty abuse and entered most of India's treaties through the Multilateral Instrument (MLI), which came into force for India on 1 October 2019. India has since been adding it bilaterally too: the India-Sri Lanka DTAA Protocol, in force from 19 June 2026, replaced the treaty's older anti-abuse clause with a PPT.

For two decades India's treaties relied on residence certificates. Mauritius-registered companies, many with little business there, used the India-Mauritius DTAA's capital gains exemption, and in 2003 the Supreme Court upheld the government's own circular accepting their TRCs. The tide turned with the OECD's BEPS project, India's GAAR and treaty renegotiations. The PPT is the treaty-side end point of that shift.

The PPT is applied by the tax authority when a non-resident claims a treaty benefit. It asks two questions in turn.

1. 1

   Step 1: Identify the benefit claimed - for example, an exemption from Indian capital gains tax under a DTAA

2. 2

   Step 2: Identify the arrangement or transaction that produced it - such as an investment held through an intermediate company in the treaty country

3. 3

   Step 3: Ask whether, on all facts and circumstances, it is reasonable to conclude that getting the benefit was one of the principal purposes. Indicators include no employees, office or decision-making in the treaty country, and income passed straight on to a third country

4. 4

   Step 4: If yes, ask whether granting the benefit would still accord with the object and purpose of the treaty provision. A genuine business with real substance can pass here

5. 5

   Step 5: If the arrangement fails both tests, deny the benefit for that item of income. In India, CBDT guidance says this applies only for periods after the PPT entered that treaty, and not to grandfathered shares held by residents of Mauritius, Singapore and Cyprus

Under the Principal Purpose Test, a treaty benefit may be denied when obtaining that benefit was: