Treaty Shopping & Substance Requirements (GAAR, LOB, MLI PPT)

By Anuj Singh | Updated March 2026

What Is Treaty Shopping?

Treaty shopping occurs when an entity with no genuine connection to a jurisdiction establishes a presence there solely to access that country's favorable Double Taxation Avoidance Agreement (DTAA) with India. The classic example: a US-based fund sets up a shell company in Mauritius — historically a zero-capital-gains-tax jurisdiction under the India-Mauritius DTAA — and routes its Indian investments through that entity. The fund claims Mauritius treaty benefits it would never qualify for under the India-US DTAA.

India has been the world's most aggressive jurisdiction in combating treaty shopping. The country deploys three overlapping anti-abuse mechanisms: the General Anti-Avoidance Rule (GAAR) under Chapter X-A of the Income Tax Act (Sections 95-102), Limitation of Benefits (LOB) clauses embedded in specific DTAAs, and the Principal Purpose Test (PPT) introduced through the OECD Multilateral Instrument (MLI). Together, these provisions mean that any foreign investor routing capital into India through an intermediary jurisdiction must demonstrate genuine commercial substance — or face denial of treaty benefits and full Indian taxation.

The January 2026 Supreme Court ruling in the Tiger Global case — involving approximately INR 14,500 crore (US$1.6 billion) in disputed capital gains from the Flipkart exit — confirmed that GAAR can override DTAA protections even for pre-2017 investments where the exit occurs after GAAR's effective date. This ruling has fundamentally altered the risk calculus for every foreign investor using intermediary holding structures for Indian investments.

Legal Basis

• Sections 95-102, Chapter X-A, Income Tax Act, 1961 — The General Anti-Avoidance Rule framework, introduced by Finance Act 2012, effective from Assessment Year 2018-19 (April 1, 2017). Empowers tax authorities to declare an arrangement an "impermissible avoidance arrangement" (IAA) and deny its tax benefits.
• Rule 10U, Income Tax Rules — GAAR does not apply where the aggregate tax benefit from an arrangement does not exceed INR 3 crore in a given assessment year.
• India-Mauritius DTAA (Third Protocol, 2016) — Amended effective April 1, 2017. Shifted capital gains taxation from residence-based to source-country taxation for shares acquired after March 31, 2017. Grandfathering applies to shares acquired before this date.
• India-Singapore DTAA (Third Protocol, 2016) — Amended effective April 1, 2017. Capital gains on shares acquired post-April 2017 are taxable in India, subject to LOB conditions requiring minimum expenditure of SGD 200,000 (approximately INR 1.25 crore) in the 24 months preceding the gain.
• MLI (Multilateral Instrument) — Entered into force for India on October 1, 2019. India adopted the PPT as the minimum standard under Article 7 of the MLI, supplemented by a simplified LOB provision.
• CBDT Circular No. 7/2017 — Clarifies that GAAR provisions can apply to treaty arrangements, overriding DTAA benefits where the arrangement is an IAA.

The Mauritius-Singapore Route: How Treaty Shopping Worked

For over two decades, the Mauritius route was the dominant channel for foreign direct investment into India. Mauritius historically accounted for over 30% of cumulative FDI inflows into India — not because Mauritius was a source of capital, but because investors worldwide used Mauritius-resident entities to access the India-Mauritius DTAA's zero capital gains tax on Indian shares.

Pre-2017: The Zero-Tax Window

Under the original India-Mauritius DTAA (signed 1983), capital gains from the sale of shares of an Indian company by a Mauritius tax resident were taxable only in Mauritius. Since Mauritius imposed zero tax on such gains, the effective tax rate was nil. A Tax Residency Certificate (TRC) issued by Mauritius was treated as sufficient proof of residence. India's Supreme Court in Azadi Bachao Andolan (2003) upheld this position, ruling that treaty shopping was not illegal.

The India-Singapore DTAA (2005) offered a similar structure: zero capital gains tax on Indian shares, subject to a Limitation of Benefits clause requiring SGD 200,000 in annual expenditure and no more than 50% passive income.

Post-2017: Source Country Taxation

The 2016 Protocol to the India-Mauritius DTAA (effective April 1, 2017) eliminated the zero-tax benefit. Capital gains on shares acquired after March 31, 2017 are now taxable in India at full domestic rates. During a two-year transition (April 2017 to March 2019), a reduced rate of 50% of the applicable Indian tax rate applied, provided the Mauritius entity met LOB requirements and was not a shell or conduit company.

GAAR: India's Primary Anti-Abuse Weapon

The General Anti-Avoidance Rule under Chapter X-A (Sections 95-102) of the Income Tax Act is India's most powerful tool against treaty shopping. Unlike LOB clauses that are treaty-specific, GAAR applies across all arrangements regardless of which DTAA is invoked.

The Four Tests for an Impermissible Avoidance Arrangement (Section 96)

An arrangement is declared an IAA if its main purpose is to obtain a tax benefit AND it meets any one of these four tests:

Consequences of a GAAR Determination (Section 98)

When an arrangement is declared an IAA, the tax authority can: disregard, combine, or recharacterize the arrangement; treat the arrangement as if it had not been entered into; reallocate income, expenditure, deductions, or relief between parties; recharacterize equity as debt (or vice versa), income as capital (or vice versa); and treat connected persons or accommodating parties as a single entity. The practical effect is that the intermediary entity is "looked through" and the ultimate investor is taxed as if they had invested directly in India.

The INR 3 Crore Threshold

Under Rule 10U of the Income Tax Rules, GAAR does not apply where the aggregate tax benefit to all parties from the arrangement does not exceed INR 3 crore in a given assessment year. This effectively means GAAR targets only large-scale arrangements — but for any significant FDI transaction, the threshold is easily crossed.

LOB Clauses in Specific DTAAs

Unlike GAAR (which is a domestic law override), Limitation of Benefits clauses are treaty-embedded provisions that restrict which residents of a contracting state can claim treaty benefits.

India-Singapore DTAA LOB Requirements

The India-Singapore DTAA contains the most detailed LOB clause among India's treaties. To claim treaty benefits, a Singapore-resident company must satisfy all of the following:

• Annual expenditure of at least SGD 200,000 (approximately INR 1.25 crore) in Singapore in the 24 months preceding the date on which the capital gain arises
• Not more than 50% of income should be passive income (interest, dividends, royalties)
• The company must not be a shell or conduit company
• The entity must have a genuine business purpose beyond obtaining DTAA benefits

India-Mauritius DTAA: No LOB, PPT Applies

The India-Mauritius DTAA does not contain a traditional LOB clause. Instead, following the 2024 Protocol, the Principal Purpose Test (PPT) serves as the sole anti-abuse provision. This makes Mauritius-routed investments more vulnerable to challenge than Singapore-routed ones, since the PPT is broader and more subjective than a mechanical LOB test.

The MLI Principal Purpose Test: The Catch-All

India ratified the OECD Multilateral Instrument (MLI) in 2019, which modified most of India's DTAAs to include the Principal Purpose Test under Article 7. The PPT entered into force for the India-Singapore DTAA from April 1, 2020, and now applies to India's treaties with the Netherlands, Luxembourg, Cyprus, and other jurisdictions.

The PPT provides: "Notwithstanding any provisions of a Covered Tax Agreement, a benefit 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 any arrangement or transaction that resulted directly or indirectly in that benefit."

Key distinctions between the PPT and GAAR:

• PPT is a treaty-level provision — it denies treaty benefits but does not recharacterize the transaction itself. GAAR goes further, allowing the tax authority to recharacterize the entire arrangement.
• PPT threshold is lower — it requires tax avoidance to be only "one of the principal purposes," whereas GAAR requires it to be the "main purpose."
• PPT has a saving clause — benefits can still be granted if the taxpayer establishes that granting the benefit is in accordance with the object and purpose of the relevant treaty provision.

Substance Requirements: What Constitutes "Substance"

Across all three anti-abuse frameworks (GAAR, LOB, PPT), the central question is whether the intermediary entity has genuine commercial substance in its country of residence. Based on the Tiger Global ruling and CBDT guidance, the following factors are examined:

• Employees: The entity must have qualified full-time employees (not just nominee directors) who actively manage the business. A single part-time director shared across multiple fund entities is a red flag.
• Office premises: A dedicated, identifiable office — not a shared registered address at a corporate services provider. Physical space with operational infrastructure is expected.
• Decision-making: Key investment decisions (buy/sell/hold, portfolio allocation, exit timing) must be made in the entity's country of residence, not directed from the parent company's home jurisdiction. Board minutes must evidence genuine deliberation.
• Financial commitment: The entity must bear real economic risk — it should have its own bank accounts, incur meaningful operating expenses (the SGD 200,000 threshold in the India-Singapore DTAA is a useful benchmark), and bear losses independently.
• Business purpose beyond tax: There must be a non-tax commercial rationale for locating the entity in that jurisdiction — regulatory advantages, access to regional markets, proximity to portfolio companies, or specific legal protections.

How This Affects Foreign Investors in India

The interplay of GAAR, LOB, and PPT creates a triple-layered scrutiny framework for any foreign investor using intermediary jurisdictions. Here is what foreign investors need to understand:

Practical Structuring Guidance

Foreign investors planning Indian investments through holding structures must ensure:

• The intermediary entity is not a conduit — it must have functions, assets, and risks beyond holding Indian shares
• Tax Residency Certificates are necessary but not sufficient. The Supreme Court in Tiger Global confirmed that a TRC is merely an "eligibility condition" for seeking treaty relief, not a guarantee of treaty benefits
• Board meetings must occur in the intermediary jurisdiction with substantive agendas and genuine decision-making, evidenced by detailed board minutes
• The entity should file Form 10F and provide all documentation required for claiming treaty benefits
• Exit planning must account for GAAR: even grandfathered shares (acquired before April 1, 2017) can lose protection if the overall arrangement is found to lack substance

The Netherlands, Luxembourg, and Cyprus Routes

Following the India-Mauritius and India-Singapore amendments, some investors shifted to Netherlands, Luxembourg, or Cyprus holding structures. However, the MLI PPT now applies to all three treaties, and India's transfer pricing and permanent establishment rules add further scrutiny layers. These routes offer no safe harbor from anti-abuse provisions.

Common Mistakes

• Relying solely on a Tax Residency Certificate to claim treaty benefits. Post-Tiger Global, Indian tax authorities are empowered to look behind the TRC and examine whether the entity has commercial substance. A TRC proves tax residence — it does not prove entitlement to treaty benefits.
• Assuming grandfathered shares are permanently protected. Shares acquired before April 1, 2017 are grandfathered under the India-Mauritius and India-Singapore DTAA amendments, but this protection can be overridden by GAAR if the overall arrangement is found to be an impermissible avoidance arrangement. Grandfathering protects the investment date, not the structure.
• Meeting LOB expenditure thresholds mechanically without genuine substance. Spending SGD 200,000 in Singapore by paying inflated service fees to related parties does not satisfy the LOB clause. The expenditure must reflect genuine operational costs of a real business.
• Ignoring the INR 3 crore GAAR threshold as a safe harbor for medium-sized investments. The threshold applies to the aggregate tax benefit across all parties to the arrangement — not per entity. A seemingly modest investment can cross the threshold when the arrangement involves multiple connected entities.
• Failing to document the non-tax business rationale for the holding structure at the time of setup. Tax authorities evaluate substance at the time of the transaction, not retroactively. If you cannot produce contemporaneous documentation showing why you chose Singapore over a direct investment, the inference of treaty shopping strengthens considerably.

Practical Example

NovaStar Capital LLC, a US-based venture capital fund, invested US$15 million in an Indian fintech company in 2019 through NovaStar Singapore Pte Ltd, a wholly-owned Singapore subsidiary. NovaStar Singapore had two employees — a fund manager and an operations analyst — a dedicated office in the CBD, and held quarterly board meetings in Singapore where investment decisions were documented.

In 2025, NovaStar Singapore sold its Indian shares for US$45 million, realizing a capital gain of US$30 million (approximately INR 250 crore). NovaStar claimed the India-Singapore DTAA benefits and reported long-term capital gains taxable in India at 12.5% (INR 31.25 crore in tax).

The Indian tax authority invoked GAAR, arguing the Singapore entity was a conduit. NovaStar defended successfully by demonstrating: (a) the Singapore entity managed investments across five Asian markets, not just India, (b) annual operating expenses exceeded SGD 500,000, well above the SGD 200,000 LOB threshold, (c) investment decisions were genuinely made in Singapore with documented board deliberations, and (d) the Singapore entity bore real economic risk, having made two loss-making investments alongside the profitable Indian exit.

Contrast this with GreenLeaf Holdings Ltd, a Mauritius entity established by the same fund in 2020 with a single nominee director, no employees, and a registered address at a corporate services provider. GreenLeaf invested US$5 million in an Indian company and exited in 2025 for US$12 million (gain of approximately INR 58 crore). The tax authority applied GAAR, denied the DTAA benefits, and assessed the gain at full Indian domestic rates. The total tax demand: INR 7.25 crore in capital gains tax plus interest and penalty of INR 2.9 crore under Section 270A — totaling INR 10.15 crore. Had GreenLeaf invested directly from the US, the India-US DTAA would have allowed source-country taxation at 12.5%, resulting in tax of only INR 7.25 crore with no penalty exposure.

Key Takeaways

• Treaty shopping — routing investments through intermediary jurisdictions solely for DTAA benefits — faces three layers of Indian anti-abuse scrutiny: GAAR (Sections 95-102), LOB clauses in specific DTAAs, and the MLI Principal Purpose Test
• The India-Mauritius and India-Singapore DTAAs were amended in 2017, ending zero capital gains tax on shares acquired after March 31, 2017. Grandfathered shares remain protected unless GAAR overrides the protection
• The Supreme Court's January 2026 Tiger Global ruling (approximately INR 14,500 crore at stake) confirmed that GAAR can override DTAA benefits and that TRCs are necessary but not sufficient for treaty protection
• GAAR applies only where the aggregate tax benefit exceeds INR 3 crore — but for any significant FDI transaction, this threshold is easily crossed
• Substance means real employees, genuine office premises, documented decision-making in the treaty jurisdiction, and a non-tax business purpose for the structure
• The MLI PPT now applies to most of India's DTAAs (including Singapore, Netherlands, Luxembourg, Cyprus) as the catch-all anti-abuse provision

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