Where GAAR and PPT Came From
The idea of general anti-avoidance rules predates BEPS itself. Continental systems have long known the doctrine of abuse of rights, and English courts—the Ramsay line, which allowed looking at a transaction as a whole, beyond individual formal steps. Over time, many states enshrined this logic in law as a statutory GAAR. In parallel, the problem of treaty shopping grew: a company would be established in a country with a favorable tax treaty solely to channel dividends, interest, or royalties through it and obtain a reduced withholding rate at source.
The response came in the form of the BEPS project of 2013–2015. Its Action 6 declared the prevention of treaty abuse one of four minimum standards, mandatory for all participants in the Inclusive Framework. The rule was delivered through the MLI—a multilateral instrument that amends multiple bilateral treaties with a single document; it opened for signature in 2017 and entered into force on July 1, 2018. This created a two-tier structure: domestic GAAR operates above national law, treaty-based PPT—above tax treaties. The mechanics of the treaties themselves and LOB are examined in the article on MLI and treaty shopping.
Concept
After the BEPS reform, international tax planning changed its logic. If previously it was sufficient to formally fit into a preferential provision or treaty, now tax authorities look at the substance of the transaction and the presence of real activity behind it. Two main instruments are used to combat artificial structures: domestic general anti-avoidance rules (GAAR) and the treaty-based principal purpose test (PPT).
GAAR: General Rule
GAAR (general anti-avoidance rule) is a general provision of national law that allows the tax authority to deny the benefit of a transaction whose main purpose was tax reduction in the absence of reasonable commercial sense. In the EU, such a rule is mandatory: Article 6 of the ATAD directive introduced a uniform GAAR in all Union countries from 2019. The United Kingdom has its own version (GAAR since 2013), as do dozens of other countries. GAAR operates above specific provisions: even if everything formally aligns, an artificial scheme can be unwound.
PPT: Treaty Test
PPT (principal purpose test) plays the same role at the level of tax treaties. It emerged as a minimum standard of BEPS (Action 6) and is embedded in the MLI—a multilateral instrument in force since July 1, 2018. The test is two-part: the tax authority must reasonably conclude that obtaining a treaty benefit was one of the principal purposes of the transaction, after which the taxpayer must prove that granting the benefit is consistent with the purposes of the treaty itself. If the argument does not hold, the benefit—for example, a reduced WHT rate on dividends—is denied.
Substance Over Form
Both instruments rely on the principle of substance over form. In practice, this means a requirement for real economic presence: people making decisions, an office, functions, and risks in the jurisdiction where the structure is registered. An empty holding company created solely for treaty purposes passes neither GAAR nor PPT.
Application
A typical conflict involves a conduit holding company that claims a reduced withholding tax under a treaty but has neither employees nor independent decision-making. Under PPT, such a structure is denied the benefit; under GAAR, the transaction is recharacterized. A defensible structure is built on the opposite: real business logic, documented board decisions, local personnel, and compliance with substance requirements.
The same conflict arises not only with dividends. A classic example from holding practice is a financing or licensing link: a loan or IP rights are placed in a company in a convenient jurisdiction, which receives interest or royalties with almost no withholding tax at source and immediately passes them on to the parent structure. If this link has no functions, no personnel, and no independent control over the income, it passes neither the beneficial owner test nor PPT. Sustainability comes from the opposite filling: real functions, decisions actually made on-site, and income that the company has the right to dispose of. How such holding chains are structured is explained in the article on holding structures.
Regulation: Lines of Defense Against Abuse
In the European Union, general GAAR ceased to be optional. Article 6 of the ATAD directive—Council Directive (EU) 2016/1164, adopted on July 12, 2016—obliged all member states to introduce a uniform rule by January 1, 2019. It covers corporate tax and allows ignoring "non-genuine" transactions whose main or one of the main purposes was to obtain a tax advantage contrary to the meaning of applicable provisions. The Parent-Subsidiary Directive also has its own anti-avoidance clause. More details on the ATAD package of measures and CFC can be found in the article on EU ATAD and CFC.
National versions are stricter on procedure. The British GAAR (Finance Act 2013) has been in force since July 17, 2013; its core is the double reasonableness test: the tax authority must show that the transaction cannot reasonably be considered a reasonable course of action. Before making an assessment under GAAR, HMRC is required to refer the case to the GAAR Advisory Panel, and the court in a dispute takes into account the Panel's opinion. Similar statutory GAARs now exist in dozens of countries—from the EU to Australia and India.
Beneficial Owner and the Danish Cases
How far the substance principle extends was shown by the EU Court in the Danish cases of 2019—concerning dividends and interest leaving the EU through transit companies. The Court for the first time explicitly recognized the prohibition of abuse as a general principle of EU law: a benefit under the directives must be denied in the case of an artificial structure, even when there is no specific provision in national law, and a transit link that does not control the received income is not recognized as its beneficial owner. A detailed analysis of the requirements and conclusions of these cases can be found in the section below; how the chain of ownership is built and who is recognized as the beneficial owner is explained in the article on beneficial ownership and nominee.
The CJEU Danish Cases: Conduits Under the General Principle of EU Law
On February 26, 2019, the Grand Chamber of the Court of Justice of the EU delivered two judgments covering six Danish disputes. The first concerned interest: the joined cases N Luxembourg 1 (C-115/16), X Denmark (C-118/16), C Danmark I (C-119/16), and Z Denmark (C-299/16), decided under the Interest & Royalties Directive. The second concerned dividends: T Danmark (C-116/16) and Y Denmark (C-117/16), under the Parent-Subsidiary Directive.
The schemes followed one pattern. A Danish company paid interest or dividends to a parent structure in Luxembourg or Cyprus—inside the EU, where the directives remove withholding tax at source. The intermediary passed the money on almost immediately: to private equity funds and parent companies outside the Union, where the directives' relief no longer reaches. The intermediate link had no functions of its own—receive and forward.
The Court said two things, and each changed practice. First: the prohibition of abuse of rights is a general principle of EU law that operates on its own. National authorities and courts must refuse a directive benefit "even if there are no domestic or agreement-based provisions providing for such a refusal"—that is, even where no such rule exists in national law, in the tax treaty, or in the directive itself. Invoking a domestic GAAR is no longer necessary: the abuse of law doctrine is built into the Union legal order.
Second: the Court described how to identify a conduit. The money moves on very soon after receipt; the recipient has no real economic activity—no staff, premises, equipment, or independent management; it has no right to dispose of the income, meaning it lacks the power to use and enjoy what it received. The concept of beneficial owner is read not formally but in light of the commentaries on the OECD Model Tax Convention, including versions adopted after the directives: the beneficial owner is the one who economically receives the income and freely decides its fate. It matters separately that the tax authority need not identify the actual beneficial owner—it is enough to show that the claimant was a transit link. The outcome under both directives was the same: the exemption was denied.
What follows for practice. The intermediary's substance has stopped being decoration: people, premises, and decisions actually taken on-site are tested on the facts, not on the charter. The right to dispose of income weighs more than title—if the money is committed onward by contract or by the design of the transaction itself, the link is not a beneficial owner, however many shares it holds. And the business purpose must be recorded in advance: why the link appeared, what functions it carries, who takes decisions and where. How dividend flows inside a holding are arranged is examined in the article on dividend distribution in a holding.
Alta Energy: Where the Line Runs on Choosing a Jurisdiction
The Canadian story shows the same problem from the other side. Luxembourg-based Alta Energy Luxembourg S.A.R.L. held shares in a Canadian oil and gas subsidiary and sold them, realizing a capital gain of more than $380 million. It paid no Canadian tax, relying on Article 13(4) of the Canada-Luxembourg treaty: the provision exempts gains on shares deriving their value from immovable property where a business is carried on in that property. The CRA attacked the transaction under Canada's GAAR, calling it classic treaty shopping.
The Supreme Court of Canada sided with the taxpayer six votes to three; Justice Côté wrote the judgment. The majority's logic: a tax treaty is a bargain between two sovereigns, and a court may not rewrite it after the fact. Residence is determined by a formal test (legal seat), the conditions of the specific article were met—so the benefit is due. The parties did not write a "sufficient substantive economic connections" requirement into the treaty text, and it cannot be read in. The GAAR, the majority stressed, was built for the unforeseen—"the GAAR was enacted to catch unforeseen tax strategies"—while Luxembourg conduits were well known when the treaty was concluded: Canada simply did not negotiate a safeguard for itself. Choosing a jurisdiction for a tax benefit is not, by itself, abuse.
Three judges were in the minority. The joint dissent of Rowe and Martin objected sharply: treaties allocate taxing rights by economic connection, and Alta's presence in Luxembourg was a pure shell—a mere conduit. The value of the dissent lies not in the losing position but in the fact that it named the criterion missing from the treaty text: the judges lacked a rule allowing them to look at the purpose of the transaction.
The main consequence sits exactly there. The case was decided under a treaty without a PPT—and that is precisely the instrument the MLI later added. After the MLI, a dispute on the same facts would run differently: the tax authority would not have to derive the "spirit" of an article through GAAR; it would be enough to show that the benefit was one of the principal purposes. Three reference points follow: the line between choosing a jurisdiction and abuse runs through the treaty text, not through a sense of fairness; the PPT moves that line and makes substance legally relevant where formal residence used to suffice; and for holding chains this means pre-MLI structures cannot be assessed by Alta's logic once the treaty is covered by the multilateral convention. The Luxembourg side of the question is examined in the article on the Luxembourg SOPARFI.
Where This Is Heading
The substance logic continues to expand. Pillar Two added the subject-to-tax rule (STTR)—a treaty rule that allows the source country to impose an additional tax on intra-group interest, royalties, and certain other payments if the recipient is taxed at a nominal rate below 9 percent. The multilateral convention on STTR, whose text was approved in October 2023, opened for signature on September 19, 2024, and is aimed primarily at protecting the tax base of developing countries. In parallel, PPT practice is growing, and administrations increasingly demand documented business reasons and real presence—what is described through substance and CIGA. The minimum tax is explained in the article on Pillar Two, and proving presence—in the article on economic substance.
Q/A
Will the PPT strip a reduced WHT rate from a holding company with no staff?
Yes. The test has two parts: the tax authority must reasonably conclude that the treaty benefit was one of the principal purposes of the arrangement, and only then does the taxpayer get to show that granting it accords with the purpose of the treaty. A company with no staff and no decisions of its own cannot carry that burden: the PPT denies the reduced rate, and a GAAR recharacterises the transaction outright.
There is no domestic rule against conduits — is the directive benefit safe?
It is not. In the Danish cases of 26 February 2019 the CJEU held that the prohibition of abuse is a general principle of EU law: authorities must refuse a directive benefit even where no such rule exists in national law, in the tax treaty or in the directive itself. The argument that the statute contains no specific provision stopped working in 2019.
Alta Energy won. Does that make choosing a jurisdiction for tax lawful?
Under a treaty with no PPT, yes. The Supreme Court of Canada held six to three that the parties never wrote a requirement of substantive economic connection into the treaty text, and a court may not read one in. Once the treaty is covered by the MLI the argument fails: the tax authority need only show that the benefit was one of the principal purposes.
Are a local director and a rented office enough to satisfy the substance test?
Not if the decisions are taken elsewhere. What is tested is factual: people, premises, functions and risks in the jurisdiction of registration — and separately the right to dispose of the income. Where the money is committed onward by contract or by the design of the deal, the link is not the beneficial owner, however many shares it holds. See economic substance.
What does the STTR change if the recipient is taxed below 9 per cent?
The source country gains the right to top up the tax. The subject-to-tax rule covers intra-group interest, royalties and certain other payments where the recipient's nominal rate is below 9 per cent. It is delivered by a separate multilateral convention, opened for signature on 19 September 2024, and is aimed above all at protecting the tax base of developing countries.