Treaty Shopping

Treaty shopping is a tax planning strategy used by businesses and individuals to take advantage of favourable tax treaties between countries. It involves routing investments or income through an intermediary country that has a beneficial Double Taxation Avoidance Agreement (DTAA) with the country where the income is generated. This helps reduce or eliminate tax liabilities, leading to substantial savings.

While treaty shopping is widely used by multinational corporations to optimise tax structures, tax authorities consider it an abuse of tax treaties when it is done solely for tax benefits, without real economic activity. Many governments, including India, have taken steps to prevent misuse by implementing anti-avoidance measures such as the General Anti-Avoidance Rules (GAAR) and the Principal Purpose Test (PPT) under BEPS (Base Erosion and Profit Shifting). These measures aim to prevent revenue loss and ensure fair taxation.

Treaty shopping in India

In India, treaty shopping has been a significant concern for tax authorities. Many companies set up holding structures in tax-friendly jurisdictions such as Mauritius, Singapore, or the Netherlands to benefit from India’s DTAA agreements. This allows them to reduce capital gains tax, dividend withholding tax, and other liabilities.

To counteract such practices, India has introduced strict anti-treaty shopping measures, including the Limitation of Benefits (LOB) clause in its tax treaties. The GAAR, introduced in 2017, also enables tax authorities to deny treaty benefits if they believe the sole purpose of the arrangement is tax avoidance. Additionally, India's adoption of Multilateral Instrument (MLI) provisions under BEPS strengthens its ability to prevent treaty abuse.

Despite these measures, treaty shopping remains a widely used practice among multinational corporations. Businesses must carefully structure their transactions to ensure compliance with Indian tax regulations and avoid legal scrutiny.

How treaty shopping works & its impact on taxation

Treaty shopping works by establishing an entity in a country that has a favourable DTAA with the income-generating country. The entity serves as an intermediary, allowing businesses or individuals to route income, investments, or capital gains through a low-tax jurisdiction to minimise tax obligations.

For example, before India amended its tax treaties, many foreign investors routed investments through Mauritius to take advantage of the DTAA, which provided capital gains tax exemptions on the sale of Indian assets. This led to a loss of tax revenue for India. In response, the government renegotiated treaties with Mauritius, Singapore, and Cyprus to introduce source-based taxation on capital gains.

The impact of treaty shopping on taxation is twofold:

• For businesses: Treaty shopping allows multinational corporations to reduce tax liabilities, enhance profitability, and optimise international tax structures. However, they must ensure compliance with evolving tax laws to avoid penalties.
• For governments: Treaty shopping can lead to erosion of the tax base, depriving governments of rightful tax revenue. To counteract this, tax authorities are tightening regulations and renegotiating tax treaties to ensure fair taxation.

Is it legal or an abuse of tax treaties

Treaty shopping is a legal but controversial practice. It is allowed under tax treaties but becomes problematic when used solely for tax avoidance, without any genuine economic activity in the intermediary country.

India has classified aggressive treaty shopping as treaty abuse and has implemented measures like GAAR, MLI, and LOB clauses to curb its misuse. The Organisation for Economic Co-operation and Development (OECD) also considers treaty shopping a harmful tax practice and promotes BEPS Action Plans to prevent exploitation.

While some businesses argue that treaty shopping is a legitimate way to optimise tax structures, tax authorities are increasingly viewing it as an abuse of tax treaties. Companies must now provide substantial economic substance in treaty jurisdictions to claim tax benefits.

Conclusion

Treaty shopping is a widely used tax planning tool that helps businesses reduce tax liabilities by leveraging international tax treaties. However, its misuse leads to significant tax revenue losses for governments, prompting countries like India to enforce stricter regulations.

With the implementation of GAAR, LOB clauses, and BEPS guidelines, treaty shopping has become more challenging. Businesses must focus on genuine economic activities and compliance with tax laws to ensure they do not violate anti-avoidance measures. Going forward, multinational corporations will need to adopt transparent and ethical tax strategies while navigating India’s evolving tax landscape. If you are looking for safe investment option, then you can consider investing Bajaj Finance Fixed Deposit. With a top-tier AAA rating from financial agencies like CRISIL and ICRA, they offer one of the highest returns, up to 8.85% p.a.

Calculate your expected investment returns with the help of our investment calculators

Investment Calculator
FD Return Calculator	Sukanya Samriddhi Yojana Calculator	Provident Fund Calculator
Recurring Deposit Calculator	PF Calculator	Gratuity Calculator