MLI Impact on India's DTAA Network: What Changed & What It Means

Why the Multilateral Instrument Matters

The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting — commonly called the MLI — is the most significant development in international tax treaty law in decades. Developed under the OECD/G20 BEPS Project, the MLI allows countries to simultaneously modify their existing bilateral Double Taxation Avoidance Agreements without renegotiating each one individually. For a country like India, with over 94 bilateral tax treaties, this mechanism offered a way to update its entire treaty network in a single instrument.

This article is part of our Complete Guide to DTAA for Foreign Companies. Here we dive deep into how the MLI has reshaped India's treaty network and what foreign companies need to know for compliance.

India signed the MLI on 7 June 2017, ratified it on 25 June 2019, and the convention entered into force for India on 1 October 2019. India listed 93 of its tax treaties as Covered Tax Agreements (CTAs) under the MLI — essentially every treaty except those with China and the Marshall Islands. This means the MLI's provisions are intended to modify nearly the entirety of India's bilateral treaty network.

For foreign companies with operations in India — whether through a wholly owned subsidiary, a branch office, or cross-border transactions — the MLI introduced several changes that directly affect treaty benefit claims, permanent establishment risk, and dispute resolution options.

What the MLI Actually Changed in India's DTAAs

Change 1: The Principal Purpose Test (PPT)

The most impactful change is the introduction of the Principal Purpose Test under Article 7 of the MLI. The PPT states that a treaty benefit shall not be granted in respect of an item of income 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 any arrangement or transaction that resulted directly or indirectly in that benefit.

India chose to adopt the PPT as a standalone anti-abuse mechanism (rather than combining it with a Simplified Limitation of Benefits clause, though India has expressed its desire to bilaterally negotiate LOB clauses with specific countries). This means the PPT applies broadly across all 93 CTAs.

The practical implications are significant. Unlike the Limitation of Benefits clause, which uses objective expenditure thresholds, the PPT is inherently subjective. Tax authorities must determine whether obtaining a treaty benefit was "one of the principal purposes" — not the sole purpose, not even the main purpose, but merely one of several principal purposes. This sets a relatively low bar for challenging treaty benefit claims.

Change 2: Treaty Preamble Update (Article 6)

Article 6 of the MLI modifies the preamble of every CTA to state that the treaty is intended to eliminate double taxation "without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in this agreement for the indirect benefit of residents of third States)."

This preamble change is not merely symbolic. It establishes the interpretive framework for the entire treaty. When Indian tax authorities or tribunals interpret ambiguous treaty provisions, the updated preamble guides them toward denying benefits in cases of perceived abuse — even where the specific treaty article might otherwise support the taxpayer's position.

Change 3: Anti-Avoidance of PE Status (Article 12)

India made a significant reservation under Article 12 of the MLI, which deals with the artificial avoidance of permanent establishment status through commissionnaire arrangements. Specifically, India reserved the right for the entirety of Article 12 not to apply to its CTAs where the existing treaty already addresses this issue. In practice, this means India has retained its domestic law approach to dependent agent PE and business connection under Section 9(1)(i) of the Income Tax Act.

However, India did not reserve against Article 13 (artificial avoidance of PE through specific activity exemptions) or Article 14 (splitting up of contracts). These provisions now modify India's DTAAs to prevent companies from artificially structuring their India activities to fall within the "preparatory and auxiliary" exemptions to PE status.

Change 4: Capital Gains on Immovable Property (Article 9)

Article 9 of the MLI extends the scope of capital gains taxation on immovable property. It allows India to tax capital gains from the alienation of shares or comparable interests (such as interests in a partnership or trust) that derive more than a specified percentage of their value from immovable property situated in India. India adopted this provision, which strengthens its ability to tax indirect transfers of Indian real estate through offshore holding structures.

Change 5: Transparent Entities (Article 3)

India made a reservation on Article 3 (transparent entities), choosing not to apply this provision to its CTAs. This means the MLI's rules on tax-transparent entities like partnerships, LLCs, and trusts do not modify India's existing treaty positions on these structures.

India's MLI Position: Key Reservations

Understanding India's reservations is as important as understanding the provisions it adopted. Here is a summary of India's key positions:

The Notification Question

A legal question has been raised regarding the enforceability of MLI provisions in India: whether the MLI automatically modifies bilateral DTAAs for Indian domestic-law purposes, or whether a country-specific notification under Section 90(1) of the Income Tax Act, 1961 is required in addition to India's deposit of its instrument of ratification with the OECD depositary.

The argument for a separate notification runs as follows: under Indian law, a DTAA becomes part of domestic law only when notified under Section 90(1). The MLI modifies DTAAs at the international level, but unless India issues a notification incorporating those modifications into domestic law, the unmodified DTAA may continue to apply for Indian tax purposes. The counter-position is that India's ratification of the MLI is itself sufficient. This issue has been raised before Indian tax tribunals and remains contested; foreign companies should obtain current legal advice on the position applicable to their treaty situation and not rely on any single ruling.

What This Means for Foreign Companies

Until the notification question is settled by higher courts or resolved by CBDT through a definitive circular, foreign companies face genuine uncertainty on whether the PPT can be applied to deny treaty benefits in specific cases. Relying on the unnotified status of MLI provisions to claim pre-MLI treaty benefits carries material litigation risk.

Even if the PPT argument is not available to the revenue, the GAAR provisions (Sections 95-102) operate independently of treaties and do not require treaty-specific notifications. Tax authorities may invoke GAAR as an alternative anti-abuse mechanism.

PPT Entry Into Force: Treaty-by-Treaty Timeline

For treaties where the MLI provisions are considered applicable (despite the ITAT uncertainty), the PPT entry into force varies by treaty partner:

Note: Mauritius has not ratified the MLI. The India-Mauritius PPT was introduced through a bilateral protocol signed on 7 March 2024, which is subject to separate ratification and notification under Section 90(1) of the Income Tax Act before it becomes enforceable in India.

Practical Impact on Foreign Companies

Impact on Withholding Tax Claims

When a foreign company claims reduced withholding tax rates on dividends, interest, royalties, or fees for technical services paid from India, the PPT now provides Indian tax authorities with a basis to challenge the claim. If the Indian payer (your subsidiary) applies the treaty rate under Section 196D or Section 195, it must be satisfied that the PPT is not triggered.

In practice, this means Indian subsidiaries and their tax advisors are increasingly requesting detailed certifications from foreign parent companies confirming the business purpose of intercompany arrangements and the absence of treaty shopping motivation.

Impact on Transfer Pricing

The MLI does not directly modify transfer pricing rules, but the PPT can interact with transfer pricing disputes. If a foreign company structures its intercompany transactions in a way that both minimizes transfer pricing exposure and accesses treaty benefits, tax authorities may argue that the arrangement's principal purpose is to obtain a treaty benefit, triggering PPT denial.

Impact on PE Risk Assessment

Articles 13 and 14 of the MLI — which India adopted — change how permanent establishment risk is assessed. Specifically:

• Anti-fragmentation rule (Article 13): Prevents companies from splitting a single integrated business activity into multiple "preparatory and auxiliary" functions to avoid PE status. If a foreign company's India activities, taken together, constitute a coherent business operation, the PE exemption for individual activities does not apply.
• Contract splitting (Article 14): Prevents companies from splitting a long-term project into multiple short-term contracts to stay below the PE time threshold (typically 183 days). Connected contracts are aggregated for PE determination purposes.

How to Respond: Compliance Roadmap for Foreign Companies

1. Audit your treaty position: Identify which of India's DTAAs governs your transactions. Check whether both India and your home country have ratified the MLI and listed the bilateral DTAA as a CTA.
2. Document business purpose: For every intercompany arrangement that relies on treaty benefits, prepare contemporaneous documentation establishing the genuine business purpose beyond tax savings. This is your primary defence against a PPT challenge.
3. Monitor ITAT decisions: The notification issue remains unresolved. If Higher Courts uphold the ITAT position, it may provide a window where the PPT is not enforceable for certain treaties. But do not structure transactions relying solely on this uncertainty.
4. Review PE exposure: If your India operations involve multiple activities that individually appear preparatory or auxiliary, assess whether they could be aggregated under the anti-fragmentation rule to constitute a PE.
5. Engage specialist advisors: The interaction between MLI, bilateral treaties, GAAR, and domestic tax law is genuinely complex. Work with tax advisory specialists who track India-specific MLI developments, or review our FEMA-RBI compliance services for broader regulatory guidance.

For related reading, see our analysis of DTAA capital gains tax planning strategies and the domestic company vs foreign company comparison for entity structure considerations.

Key Takeaways

• India listed 93 DTAAs as Covered Tax Agreements under the MLI, introducing the Principal Purpose Test (PPT) as the primary anti-abuse mechanism across its treaty network.
• The PPT sets a low threshold for denial — if obtaining a treaty benefit is "one of the principal purposes" (not even the main purpose) of an arrangement, benefits can be denied.
• The enforceability of MLI provisions in India, absent a country-specific notification under Section 90(1) of the Income Tax Act, is contested before Indian tribunals and remains unsettled — creating legal uncertainty for treaty-benefit claims.
• India adopted anti-fragmentation and contract-splitting rules that increase PE risk for foreign companies with multiple India activities.
• Foreign companies should document genuine business purpose for all treaty benefit claims and monitor ongoing judicial developments on the notification issue.