ECONOMYNEXT – India’s current modification to its Double Taxation Avoidance Settlement (DTAA) with Sri Lanka is greater than a routine treaty replace. Based on Deloitte Sri Lanka, it displays a world shift in direction of stronger measures to forestall tax avoidance and raises an essential query, ought to Sri Lanka now modernise its personal tax treaty framework to maintain tempo with worldwide developments?
The Protocol amending the India–Sri Lanka DTAA was signed on 16 December 2024 and entered into power on 19 June 2026 after each international locations accomplished their home procedures. India notified the Protocol on 16 July 2026, and the amendments will apply in India for fiscal years starting on or after 1 April 2027.
The Protocol introduces two key modifications that make it tougher for companies to make use of tax treaties purely to cut back their tax liabilities.
First, it updates the treaty’s preamble to make clear that the Conference is meant to remove double taxation with out creating alternatives for non-taxation or diminished taxation via tax evasion or avoidance, together with via treaty-shopping preparations.
Second, it introduces the Principal Objective Check (PPT), an internationally recognised rule designed to forestall treaty abuse. In easy phrases, if a enterprise construction has been arrange primarily to realize a tax benefit, the tax treaty advantages could also be denied. Real business investments stay protected, whereas preparations with little actual enterprise function might not qualify for treaty advantages.
These amendments implement the OECD/G20 Base Erosion and Revenue Shifting (BEPS) Motion 6 minimal commonplace on stopping treaty abuse. Lots of India’s treaty companions adopted these requirements via the Multilateral Instrument (MLI). Sri Lanka, nonetheless, has not joined the MLI, that means that treaty modernisation can solely happen via bilateral negotiations. From Deloitte’s perspective, these developments spotlight the rising significance of making certain tax treaties assist real enterprise exercise whereas stopping their misuse.
The modifications additionally spotlight a broader situation for Sri Lanka. As Sri Lanka has not adopted the Multilateral Instrument (MLI), updating its tax treaties requires separate negotiations with every treaty companion. This will sluggish treaty modernisation and create inconsistencies throughout Sri Lanka’s treaty community till broader reforms are launched.
Sri Lanka’s home guidelines alone might not at all times be sufficient to deal with treaty abuse as a result of eligibility for treaty advantages is often decided by the treaty itself. The place a treaty doesn’t comprise fashionable anti-abuse provisions, uncertainty can come up over whether or not home guidelines alone are sufficient to forestall treaty abuse. As worldwide tax requirements more and more concentrate on whether or not a enterprise has a real business function, relatively than merely assembly authorized necessities on paper, it turns into much more essential for home legal guidelines and tax treaties to work collectively.
This method applies throughout many sorts of cross-border transactions. For instance, if an organization is about up primarily to acquire tax treaty advantages relatively than for real enterprise causes, the tax authorities might refuse to grant these treaty advantages. In such instances, the transaction itself just isn’t disallowed, however the enterprise might lose the tax profit provided by the treaty and turn out to be topic to the conventional home tax guidelines.
Equally, the identical substance-based method may be related to sure cross-border intra-group service preparations. Beneath lots of Sri Lanka’s tax treaties, funds for administration and different intra-group companies are usually not characterised as royalties and, with restricted exceptions, might fall exterior the scope of source-country withholding tax. The place treaty safety is relied upon, tax authorities are more and more prone to study whether or not the underlying preparations replicate real business substance and enterprise function, relatively than merely the authorized type of the transaction.
Commenting on this, Charmaine Tillekeratne, Accomplice and Head of Tax at Deloitte Sri Lanka and Maldives, stated:
“Worldwide tax guidelines are evolving quickly, and companies ought to view these modifications as a possibility to strengthen governance and guarantee their cross-border buildings are constructed on real business function. Taking proactive steps at present may help organisations handle future regulatory modifications with better confidence.”
Whether or not the transaction entails holding buildings, financing preparations, licensing, intra-group companies, or oblique transfers, the frequent query more and more being requested by tax authorities just isn’t merely whether or not the authorized necessities have been met, however whether or not the association is supported by real business function and financial substance.
Deloitte encourages companies working between India and Sri Lanka to look past the authorized type of their corporations and concentrate on constructing clear, well-governed funding buildings. Companies that depend on treaty advantages ought to assessment their preparations to make sure they’re supported by real business function and a transparent enterprise rationale.
Deloitte believes these developments present a possibility for Sri Lanka to modernise its tax treaty community and align it with evolving worldwide requirements. A contemporary treaty framework may help shield the nation’s tax base whereas supporting sustainable cross-border funding. Deloitte stays dedicated to serving to organisations navigate these modifications and reply confidently to an evolving international tax panorama. (Colombo/Jul25/2026)
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