Limitation of Benefit (LOB) clause

A tax treaty between India and another country exists so income is not taxed twice — once in India, once again where the investor lives. But a treaty written to help genuine residents of that other country can be misused by someone who simply parks an entity there to borrow its treaty benefits, with no real business or presence in the country at all. That misuse is called treaty shopping.

A Limitation of Benefit (LOB) clause is the treaty's own defence against it: a provision written into the tax treaty itself that denies the reduced tax rates and reliefs to an entity that does not meet a substance test — genuine ownership, business activity or presence in the treaty country — even though the entity is technically resident there.

The workbook introduces the LOB clause inside its discussion of GAAR (Chapter 14, section 14.3), while covering the CBDT's clarifications on implementing GAAR, issued 27 January 2017.

One of those clarifications is direct: "Where tax avoidance is sufficiently addressed by the Limitation of Benefit Clause (LOB) in a Tax Treaty, GAAR shall not be invoked." In other words, the LOB clause and GAAR do the same policing job — stopping tax benefits from going to arrangements with no genuine substance — and where a treaty already carries its own LOB clause, the tax authorities are not meant to reach for the broader domestic GAAR power on top of it.

The workbook places this alongside the wider anti-avoidance architecture an AIF must navigate when structuring an offshore fund: the Multilateral Instrument (MLI), which India ratified with effect from 1 October 2019 to modify its tax treaty network and prevent Base Erosion and Profit Shifting, and GAAR itself, which has applied in India since 1 April 2017. GAAR carries its own materiality point too — the CBDT clarified that GAAR's INR 3 crore (30 million) tax-benefit limit is to be read against the arrangement as a whole, not against a single taxpayer.

The fund structure is illustrative; the LOB and GAAR framework is the workbook's.

An offshore fund pooling capital from European investors is set up in a jurisdiction with a favourable India tax treaty. It plans to invest Rs 300 crore into Indian listed and unlisted securities through a Category III AIF route.

The fund's promoters propose to route the investment through a shell entity in the treaty jurisdiction — a company with no staff, no office and no board meetings held locally — purely to claim the treaty's reduced withholding tax on dividends and interest.

If that treaty carries an LOB clause, the Indian tax authority can deny treaty benefits to this entity directly, on the ground that it fails the substance test the LOB clause sets — without needing to invoke GAAR at all. Per the CBDT's 2017 clarification, GAAR is reserved for cases the LOB clause does not already reach.

Had the promoters instead set up a genuine local presence — directors resident in the treaty jurisdiction, real board decisions taken there, a functioning office — the entity would likely clear the LOB test, and the treaty benefit would stand.

Chapter 14, section 14.3 (General Anti-Avoidance Rules) and section 14.4 (Multilateral Instrument) sit together in the taxation chapter, and the LOB clause is examined as part of the same block — expect a question on which CBDT clarification says GAAR will not be invoked (the one addressing the LOB clause), and questions distinguishing the GAAR Rs 3 crore limit (per arrangement, not per taxpayer) from the LOB clause's own substance test.

This matters directly for offshore AIF structuring, covered in Chapter 6, where the workbook discusses Mauritius- and Singapore-domiciled offshore and feeder funds — exactly the structures an LOB clause is written to police.

• The LOB clause sits inside the tax treaty itself; GAAR sits in India's domestic tax law. They overlap in purpose but are not the same instrument, and CBDT's 2017 clarification treats the LOB clause as the first line of defence.
• "GAAR shall not be invoked" is conditional, not automatic — it applies only where the LOB clause already sufficiently addresses the avoidance; a weak or absent LOB clause leaves GAAR available.
• The Rs 3 crore GAAR threshold is read against the arrangement, not the taxpayer — the CBDT was explicit that this is not a per-investor limit.
• Being resident in a tax-efficient jurisdiction is not, by itself, a GAAR trigger — the workbook's clarification says GAAR shall not be invoked merely on that ground either; it is the absence of substance that matters, which is exactly what an LOB clause tests for.
• MLI (2019) and GAAR (2017) are different tools with different start dates — do not merge the two into one date.