India Cracks Down on Treaty Shopping, Seeks "Real" Foreign Investors

The Indian Income Tax Department is stepping up its efforts to fight against companies and individuals trying to avoid taxes by misusing international tax agreements. Recent reports indicate that the department has sent detailed notices to many foreign individuals and companies, especially those based in places like Singapore, Mauritius, and Cyprus, which are often seen as tax-friendly locations.

What is "treaty shopping"? 

The main concern for the tax department is "treaty shopping". This happens when companies use Tax Residency Certificates (TRCs) from countries with lower tax rates to wrongly claim tax benefits under India's Double Taxation Avoidance Agreements (DTAAs). These agreements are designed to prevent the same income from being taxed twice in two different countries. 

However, the Indian tax authorities now believe that simply having a TRC is not enough. They want foreign investors to prove that their companies have a real business purpose, actual economic activity, and that important decisions are made in the country where the company is based. 

IT Dept. is Focusing on Shell Companies 

The tax department is particularly focused on "Intermediate Holding Companies" (IHCs) set up in places like Mauritius and Singapore. They suspect many of these companies are just "shell" or "conduit" companies – meaning they exist mostly on paper without real business operations – created only to get lower tax rates in India.

The notices sent out ask tough questions like: Who truly benefits from the investments in India? Why was the IHC set up in a tax haven? Who makes the important decisions for the company? How many employees does it have on the ground? What kind of business does it actually do?

Addition of New Rules to Prevent Treaty Shopping

This crackdown is part of India's larger plan to enforce rules designed to prevent tax abuse. These include the "Multilateral Instrument" (MLI) and the "General Anti-Avoidance Rules" (GAAR). Under these rules, a "Principal Purpose Test" (PPT) has been introduced. This allows tax authorities to deny tax treaty benefits if they believe the main reason for an arrangement was to get a tax advantage.

A Shift in Approach

Historically, Indian courts have often accepted TRCs as enough proof to claim treaty benefits. However, the tax department is now taking a tougher stance, arguing that actual control, business activity, and who truly owns the company must also be considered. This new approach has already led to legal disputes, with foreign investors challenging these notices.

While courts have generally sided with taxpayers in the past, recent judgements show a more careful approach. This means foreign investors must now be more diligent in showing that their investment companies have a real business reason for existing.

Read more on: ITR Filing 2025: Why You Should Wait Till June 15, 2025 

Conclusion 

India's tax department is making it clear that it will scrutinise foreign investments to prevent tax treaty abuse. While this aims to ensure fair taxation, clearer guidelines from the government are crucial to provide certainty for foreign investors and maintain India's appeal as an investment destination.
 
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