India Notifies Protocol Amending India–Sri Lanka DTAA
India Notifies Protocol Amending India–Sri Lanka DTAA: Principal Purpose Test (PPT) to Apply from FY 2027-28
The Central Government has officially notified the Protocol amending the Double Taxation Avoidance Agreement (DTAA) between India and Sri Lanka. The amendment aligns the bilateral tax treaty with internationally accepted anti-tax avoidance standards by incorporating the Principal Purpose Test (PPT) and updating the treaty’s preamble.
The notification has been issued under Section 159(1) of the Income-tax Act, 2025, giving legal effect to the Protocol signed between the two countries.
Background of the Amendment
India and Sri Lanka originally signed the DTAA on 22 January 2013 to eliminate double taxation and prevent fiscal evasion with respect to taxes on income.
To strengthen the treaty and bring it in line with the recommendations under the OECD’s Base Erosion and Profit Shifting (BEPS) project, both countries signed an amending Protocol on 16 December 2024 in New Delhi.
Following the completion of domestic legal procedures by both countries, the Protocol entered into force on 19 June 2026.
Effective Date in India
Although the Protocol became effective on 19 June 2026, its provisions will apply in India from the financial year beginning on or after 1 April 2027.
Accordingly, the amended provisions will generally be applicable from FY 2027-28 (Assessment Year 2028-29) onwards.
Key Changes Introduced by the Protocol
1. Updated Preamble to the DTAA
The Protocol replaces the existing preamble of the India–Sri Lanka DTAA with a revised version that reflects the modern objective of tax treaties.
The revised preamble makes it clear that the agreement seeks to:
- Eliminate double taxation between India and Sri Lanka.
- Prevent fiscal evasion relating to income taxes.
- Promote economic cooperation and cross-border investment.
- Ensure that treaty benefits are not used to facilitate tax evasion or aggressive tax avoidance.
Importantly, it clarifies that the treaty is not intended to create situations of double non-taxation or artificial tax reduction through treaty shopping arrangements.
2. Introduction of the Principal Purpose Test (PPT)
One of the most significant amendments is the replacement of the existing anti-abuse provision with the Principal Purpose Test (PPT).
Under the PPT, a taxpayer may be denied treaty benefits if it is reasonable to conclude that obtaining those benefits was one of the principal purposes of an arrangement or transaction.
However, treaty relief may still be granted if the taxpayer can demonstrate that granting the benefit is consistent with the object and purpose of the relevant treaty provisions.
The PPT is now a globally accepted anti-abuse rule and has been incorporated into many of India’s tax treaties.
What is Treaty Shopping?
Treaty shopping refers to arrangements where a person routes investments or transactions through another country primarily to obtain favourable tax benefits under a tax treaty, even though that country has little or no genuine commercial connection with the transaction.
The introduction of the PPT aims to discourage such structures and ensure that treaty benefits are available only where there is genuine economic substance.
Impact on Taxpayers
The amendment is expected to affect multinational enterprises, foreign investors, and businesses undertaking cross-border transactions between India and Sri Lanka.
Taxpayers claiming treaty benefits should ensure that:
- Their business structures have genuine commercial substance.
- Transactions are undertaken for valid business reasons.
- Documentation adequately supports the commercial purpose of the arrangement.
- Tax treaty benefits are not the primary motivation behind the transaction.
Entities relying on the India–Sri Lanka DTAA should review their existing investment and financing structures before the amended provisions become applicable.
Why This Amendment Matters
The Protocol reflects India’s continued efforts to modernize its tax treaty network and implement internationally accepted measures against treaty abuse.
By introducing the Principal Purpose Test and strengthening the treaty’s objectives, both India and Sri Lanka aim to strike a balance between facilitating cross-border investment and preventing misuse of treaty benefits.
Conclusion
The notification of the India–Sri Lanka DTAA Protocol marks another important step in India’s implementation of global anti-tax avoidance standards. While the amended treaty continues to provide relief from double taxation, it also introduces stricter conditions for claiming treaty benefits through the Principal Purpose Test.
Businesses and investors engaged in India–Sri Lanka cross-border transactions should assess their structures well before the amended provisions become applicable from FY 2027-28 to ensure continued eligibility for treaty relief.
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