India's MLI Notification Gap: Is the Principal Purpose Test Legally Enforceable Under Domestic Law?
Overview
A fundamental legal controversy is quietly reshaping the landscape of international tax enforcement in India. The dispute does not turn on whether a particular cross-border structure was abusive or commercially justified — it turns on something far more elementary: whether the Principal Purpose Test (PPT), India's primary treaty-level anti-avoidance weapon, was ever validly incorporated into Indian domestic law in the first place.
A series of rulings from the Income Tax Appellate Tribunal (ITAT), originating with the Sky High Leasing decision in August 2025, has taken a firm position — that India's 2019 ratification of the OECD/G20 Multilateral Instrument (MLI) did not, by itself, give the PPT enforceable domestic legal status. The reason: India failed to issue individual, treaty-specific notifications as required under Section 90(1) of the Income-tax Act, 1961, for each Double Taxation Avoidance Agreement (DTAA) modified by the MLI.
If this reasoning is ultimately upheld by the higher judiciary, a significant volume of post-2020 treaty-shopping enforcement actions could be rendered legally infirm — not on their substantive merits, but on a foundational question of domestic implementation.
The Foundation: What the Supreme Court Held in Nestlé SA
The MFN Clause Dispute
To understand the Sky High line of cases, one must begin not with the MLI, but with the Supreme Court's landmark judgment in Assessing Officer v. Nestlé SA, which examined the Most Favoured Nation (MFN) clauses embedded in the protocols to India's DTAAs with the Netherlands, France, and Switzerland.
These MFN clauses operate on the principle that if India subsequently extends more favourable tax treatment to residents of another OECD member state, the same benefit must automatically flow to the residents of the MFN-protected treaty country. Assessees argued that the benefit crystallised automatically at the time the triggering event occurred.
The Supreme Court's Twin Rulings
The Supreme Court rejected this position on two distinct grounds:
OECD Membership Timing: The third country had to be an OECD member at the time it concluded its own treaty with India — not merely at the time the assessee sought to invoke the MFN clause.
The Notification Requirement — The More Consequential Ruling: Even where an MFN benefit is validly triggered at the international level, it does not automatically become enforceable under Indian domestic law.
Section 90(1)of the Income-tax Act, 1961 mandates that the Central Government must give effect to a DTAA — or any protocol amending it — through a specific notification published in the Official Gazette. Without such a notification, no court, tribunal, or authority can apply the amended treaty provision within India.
The Court's position was unambiguous: India operates under a dualist framework with respect to international law. Ratification of an international instrument binds India under public international law, but it does not automatically alter domestic rights and obligations. Separate domestic incorporation is mandatory.
Crucially, the Court's reasoning was not confined to MFN clauses alone. It extended, in principle, to any protocol or agreement that alters existing treaty terms — setting the stage for its direct application to the MLI.
The Sky High Cases: Applying Nestlé SA to the MLI
India's 2019 MLI Ratification — What Was Done and What Was Not
India signed and ratified the MLI in 2019. Through a single covering notification, India declared:
- The list of DTAAs it wished to designate as "Covered Tax Agreements" under the MLI
- The specific MLI provisions it intended to apply — including Article 6 (Purpose of a Covered Tax Agreement) and Article 7 (Prevention of Treaty Abuse — the PPT)