DTAA Planning for Foreign LPs — Treaty Shopping Limits Post-MLI

For close to two decades, the India-Mauritius Double Taxation Avoidance Agreement (DTAA) was the single most consequential piece of tax planning available to foreign investors accessing Indian markets. That era is now largely over for new investments, and a foreign LP evaluating an Indian AIF allocation in 2026 is planning in a fundamentally different treaty environment — one shaped by the 2016-17 source-taxation protocols, India's General Anti-Avoidance Rules (GAAR), and, most recently, the Multilateral Instrument's (MLI) Principal Purpose Test (PPT), on which India's Central Board of Direct Taxes issued important clarifying guidance as recently as January 2025.

How We Got Here: The End of Unconditional Capital Gains Exemption

Until 2016, the India-Mauritius DTAA (and, by a linked Limitation of Benefits provision, the India-Singapore DTAA) allowed capital gains on the sale of Indian shares by a Mauritius or Singapore tax resident to be taxed exclusively in the country of residence — meaning, in practice, not taxed at all, since neither jurisdiction taxed such gains domestically. This made a Mauritius or Singapore holding structure close to a default choice for foreign portfolio and private equity investment into India for years.

Protocols signed in 2016 (Mauritius and Singapore) and separately with Cyprus amended this: capital gains on shares acquired on or after April 1, 2017 became taxable in India on a source basis, at applicable Indian rates. Critically, both protocols included a grandfathering clause — investments in shares acquired before April 1, 2017 continue to benefit from the exemption under the pre-amendment treaty terms, regardless of when they are eventually sold.

The Principal Purpose Test and the January 2025 CBDT Clarification

The MLI, which entered into force for India on October 1, 2019, introduced the Principal Purpose Test as a minimum anti-abuse standard across India's covered tax treaties — denying treaty benefits where obtaining that benefit was "one of the principal purposes" of an arrangement, unless granting the benefit would be consistent with the object and purpose of the relevant treaty provision.

For a period, this created real uncertainty for holders of grandfathered pre-2017 investments: did the PPT override the grandfathering protection, effectively creating a new anti-abuse test that grandfathered investments would still have to satisfy? This mattered enormously in practice — a Mauritius-based investor holding shares acquired in, say, 2015, with an eventual exit planned for 2026 or later, needed to know whether that exit would face fresh PPT scrutiny notwithstanding the grandfathering clause.

The CBDT's Circular No. 1/2025, dated January 21, 2025, resolved this directly: the PPT applies prospectively, and grandfathering provisions under India's treaties with Mauritius, Singapore, and Cyprus are not intended to interact with the PPT — meaning grandfathered pre-April 2017 investments remain governed purely by the specific grandfathering terms of the relevant treaty, without an additional PPT overlay. For Singapore specifically, the circular notes the PPT takes effect from April 1, 2020, and grandfathering benefits remain subject to the India-Singapore treaty's existing Limitation of Benefits (LOB) clause and specific tests, independent of the PPT. For Mauritius, notably, the treaty has no LOB clause at all — the PPT (once the 2024 protocol formalising its inclusion is ratified) stands as the sole anti-abuse provision, while the grandfathering clause continues to operate on its own terms.

This is a meaningful, current clarification: it means foreign LPs holding legacy pre-2017 Mauritius or Singapore structures have considerably more certainty than they did through most of 2024, though the CBDT circular itself notes that revenue authorities retain the ability to challenge a transaction under general principles where there is fraud, a sham arrangement, or a complete absence of economic substance — grandfathering is not, and was never intended to be, a shield for transactions with no genuine commercial rationale.

What This Means for New Investments Going Forward

For any investment made on or after April 1, 2017 — which, for a fund raising and deploying capital today, is the entire relevant universe — grandfathering is simply not available. A foreign LP's treaty position for new capital deployed through a Mauritius, Singapore, or Cyprus structure today depends entirely on:

• Source-based capital gains taxation applying at ordinary Indian rates, since the pre-2017 exemption era does not apply to new acquisitions.
• Satisfying the PPT on its own terms — meaning the structure must be able to demonstrate that obtaining treaty benefit was not "one of the principal purposes" of the arrangement, which in practice requires genuine economic substance: real management and control activity in the treaty jurisdiction, staffing and decision-making presence commensurate with the fund's scale, and a commercial rationale for the jurisdiction choice independent of tax outcome.
• For Singapore specifically, also satisfying the LOB test — a more mechanical, objective substance requirement (commonly including minimum local expenditure thresholds and listed-company/bona-fide-business tests) that operates alongside, and independently of, the PPT's more subjective "principal purpose" inquiry.

Interaction With India's GAAR

India's General Anti-Avoidance Rules, in force since April 1, 2017 (Chapter X-A of the Income-tax Act, 1961), give Indian tax authorities an independent, domestic-law basis to deny tax benefits — including treaty benefits — where an arrangement's main purpose is to obtain a tax advantage and it lacks commercial substance, characterised as an "impermissible avoidance arrangement." A CBDT circular dated January 27, 2017 clarified that GAAR generally will not be separately invoked where a case of treaty abuse is already adequately addressed through a treaty's own Limitation of Benefits clause — meaning GAAR and treaty-level anti-abuse provisions (LOB, and now PPT) are intended to work as a coordinated, rather than duplicative, anti-abuse framework, though the precise interaction as PPT becomes more prevalent across India's treaty network continues to be an evolving area of interpretation.

Practical Substance Requirements for Foreign LP Structures

Given that PPT (and, for Singapore, LOB) scrutiny now applies to essentially all new India-facing treaty structures, foreign LPs and fund managers structuring holding vehicles should build genuine substance into the structure from formation, not retrofit it defensively if challenged:

• Local management and control — board meetings genuinely convened and substantively conducted in the treaty jurisdiction, with decision-making authority (not just ceremonial approval) exercised there.
• Adequate local staffing and physical presence — proportionate to the size and complexity of the fund, avoiding a "letterbox" profile with no employees or operational footprint.
• Independent commercial rationale — a genuine business reason for the jurisdiction choice beyond treaty benefit, such as access to the jurisdiction's broader fund ecosystem, regulatory framework, or investor base.
• Contemporaneous documentation — board minutes, expenditure records, and decision-making trails maintained as the arrangement operates, since PPT and GAAR challenges are fact-intensive and retrospective documentation reconstruction is far weaker evidence than a contemporaneous paper trail.

Practical Guidance for Foreign LPs Evaluating Indian AIF or Offshore Fund Exposure

• Legacy pre-2017 structures: confirm with tax counsel that the specific investments in question genuinely qualify for grandfathering (acquisition date, instrument type, and any intervening restructuring can all affect eligibility) — the January 2025 clarification protects grandfathered transactions from PPT, but only if grandfathering itself is correctly established on the facts.
• New capital deployment: treat treaty benefit as a secondary consideration behind genuine structural and commercial rationale — a jurisdiction choice built primarily around fund domicile familiarity, ecosystem access, and governance quality (as discussed in our companion piece comparing Indian AIF and offshore fund structures) is both a more defensible PPT position and, increasingly, the more realistic basis on which such decisions are actually being made across the industry.
• Direct Indian AIF investment: where a foreign LP invests directly into an Indian AIF rather than through an offshore blocker, the LP's own home-country treaty position with India (not Mauritius or Singapore treaty planning) governs their outcome, given the AIF's pass-through tax character — a materially different, and for many LPs simpler, analysis.

Conclusion

The India-Mauritius and India-Singapore treaties remain relevant, valuable planning tools — but the planning question has fundamentally shifted from "which treaty offers the best exemption" to "does this structure have genuine economic substance that will withstand PPT, LOB, and GAAR scrutiny." The January 2025 CBDT clarification removed one significant source of uncertainty for legacy grandfathered holdings, but for every rupee of new capital deployed today, substance — not treaty selection alone — is what determines whether treaty benefits actually hold up.