International Tax Update: Landmark Ruling On SC Lowy: Principal Purpose Test Under The India-Luxembourg Tax Treaty

In a precedent-setting decision, the Delhi Bench of the Income Tax Appellate Tribunal (ITAT) ruled in favor of SC Lowy P.I. (Lux) S.A.R.L., addressing the applicability of the Principal Purpose Test (PPT) under the India-Luxembourg Double Taxation Avoidance Agreement (DTAA), as modified by the Multilateral Instrument (MLI). This judgment is significant as it marks the first application of the PPT by an Indian tribunal in the context of cross-border investment and treaty benefits.

Background

SC Lowy P.I. (Lux) S.A.R.L., a Luxembourg-incorporated company and a Category II Foreign Portfolio Investor (FPI) registered with SEBI, invested in various Indian debt instruments including non-convertible debentures and pass-through certificates. It is a wholly owned subsidiary of a Cayman Islands-based entity and has reported the following income for the assessment year 2021–22:

• Interest Income: ₹3.38 crore, offered to tax at 10% under Article 11 of the DTAA
• Business Income: ₹2.37 crore, claimed exempt under Article 7 of the DTAA (no permanent establishment)
• Capital Gains: ₹37.46 crore, claimed exempt under Article 13(6) of the DTAA

The company also held a valid Tax Residency Certificate (TRC) issued by Luxembourg authorities and had filed tax returns and paid tax on its global income in Luxembourg.

Tax Authority's Allegations

The Indian tax authorities denied the treaty benefits, alleging that:

• The Luxembourg entity was a conduit created for treaty shopping
• The company lacked real economic substance
• It was not the beneficial owner of the income
• The principal purpose of the arrangement was to obtain treaty benefits, thereby triggering the Principal Purpose Test (PPT) under the MLI

The assessing officer relied on the fact that the parent company was based in the Cayman Islands, and questioned the commercial rationale of establishing the entity in Luxembourg.

Tribunal's Key Observations

The ITAT made the following crucial findings:

1. Economic Substance and Commercial Rationale

The Tribunal held that SC Lowy had sufficient economic substance in Luxembourg. It incurred operating expenses (including audit, legal, consulting, and administrative fees), made global investments, and had a demonstrable business rationale for its structure¹.

2. Beneficial Ownership

No evidence was presented to suggest that SC Lowy was under a contractual or legal obligation to pass through its Indian income to any other party. It retained control over its income and investments, and thus qualified as the beneficial owner².

3. Validity of the TRC

The Tribunal reiterated that a valid TRC is prima facie proof of tax residency and must be respected unless there is credible contrary evidence, which was absent in this case³.

4. Application of the Principal Purpose Test (PPT)

While acknowledging the relevance of the PPT introduced by the MLI, the Tribunal held that the burden of proof lies with the tax authorities to demonstrate that obtaining treaty benefits was a principal purpose of the structure. Mere assertions without factual backing are insufficient. In this case, no such conclusive evidence was furnished by the tax authorities⁴.

Conclusion

The ITAT's ruling provides much-needed clarity on the application of treaty provisions post-MLI and establishes a high threshold for invoking the Principal Purpose Test. It confirms that:

• Foreign investors can rely on valid TRCs and DTAA protections, provided they demonstrate real substance and beneficial ownership
• Tax authorities must meet a significant evidentiary burden to deny treaty benefits based on PPT

This ruling strengthens investor confidence in India's treaty network and underlines the importance of maintaining robust substance and transparency in cross-border structures.

Footnotes

1. ITAT Delhi Bench 'D', SC Lowy P.I. (Lux) S.A.R.L. v. ACIT, https://indiankanoon.org/doc/39588531/

2. "India vs SC Lowy P.I. (Lux): Principal Purpose Test Applied", Academy of Tax Law, https://academyoftaxlaw.com/india-vs-sc-lowy-p-i-lux-international-tax-case/

3. Ibid.

4. Nishith Desai Associates, "PPT Invoked for First Time in India: ITAT Decision in SC Lowy Case", March 2025.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.