Direct Tax Alert - SC holds that applicability of ‘Most Favoured Nation’ (MFN) clause is not automatic

BACKGROUND

In order to promote trade and business, India has entered into a number of Double Tax Avoidance Agreements (DTAA or Tax Treaty or Treaty) to address the problem of double taxation. Some of its DTAAs contain the Most Favoured Nation (MFN) clause. As per this clause, if India enters a DTAA on a later date with a third country which is an Organisation for Economic Co-operation and Development (OECD) member, providing a beneficial rate of tax or restrictive scope for taxation, a similar benefit will be available to the first country.

While the MFN Clause provides access to beneficial tax rates and scope, the application of this clause has been a matter of litigation in India over the last few years. Delhi High Court in the case of Concentrix Services Netherlands BV¹ has examined this issue and held that the MFN clause shall be applicable from the date when the third State became an OECD member country. Please click here to read our alert on the ruling in detail.

Subsequently, the Central Board of Direct Taxes (CBDT) issued a Circular giving clarification on the applicability of the MFN Clause². Please click here  to read our alert on the same.

Apart from Concentrix, there were other pronouncements wherein the High Court³ had allowed the benefit of the MFN clause. Hence, the Revenue Authorities filed an appeal before the Hon’ble Supreme Court (SC or Apex Court). Recently, the Apex Court⁴ has pronounced its verdict holding that the MFN clause cannot be applied automatically and that a notification from Indian revenue authorities is required for its application.

We, at BDO in India, have summarised this ruling and provided our comments on the impact of this decision hereunder:

FACTS OF THE CASE

The facts pertaining to different matters before the SC are briefly mentioned hereunder:

1. Steria (India) Limited (Steria)

• In the case of Steria, the taxpayer regarding clause 7 of the Protocol to India-France DTAA, imported the definition of ‘fees for technical services’ (FTS) as provided in India-UK DTAA.
• Aggrieved by the order of Advance Authority for Ruling, a writ petition was filed before Hon’ble Delhi HC. The Hon’ble Delhi HC held that a Protocol is considered part of the DTAA itself and does not have to be separately notified for the purposes of application of the MFN clause.

2. Concentrix Services Netherlands BV and Optum Global Solutions International BV

• The taxpayers and residents of the Netherlands were subject to receipt of dividends from their wholly-owned Indian subsidiaries. With the abolishment of the Dividend Distribution Tax (DDT), taxpayers made an application under section 197 of the Income-tax Act, 1961 (IT Act) with the Tax Officer for issuance of a lower withholding (WHT) certificate at the rate of 5%⁵.
• Aggrieved, taxpayers filed a writ petition before Delhi HC and the Hon’ble Delhi HC allowed the taxpayer’s claim of a 5% withholding rate by stating that benefit under the MFN clause could be extended from the date on which a Contracting state becomes a member of the OECD.

3. Nestle SA

• The taxpayer, resident of Switzerland, based on the MFN clause contained in India- Switzerland DTAA imported the lower tax rate of 5% from India-Lithuania DTAA and applied for a lower WHT certificate at the rate of 5%. The tax authorities rejected the application for lower WHT.
• Aggrieved, the taxpayer filed a writ petition before Hon’ble Delhi HC. The Hon’ble Delhi High Court allowed the taxpayer’s claim by relying on its decision in the case of Concentrix Services (supra).

Supreme Court’s Ruling

Hon’ble Supreme Court came to the following conclusion:

• Notification under Section 90 of the IT Act is a necessary and mandatory condition for a Court, Authority or Tribunal to give effect to DTAA or any Protocol which has the effect of altering the existing provisions or law;
• The requirement that beneficial treatment contained in DTAA entered with one nation (say X Country) (subject to it being part of OECD) subsequent to entering into DTAA with another nation (say Y Country), will not operate automatically. In other words, the benefit contained in DTAA with X Country cannot be applied automatically into the DTAA with Y Country. In such event, the terms of the earlier DTAA (i.e., with Y Country) require to be amended through a separate notification under Section 90 of the IT Act;
• The interpretation of the expression “is” has present signification. Therefore, for a party to claim the benefit of a “same treatment” clause, based on the entry of DTAA between India and another state which is a member of OECD, the relevant date is entering into a treaty with India, and not a later date, when, after entering into DTAA with India, such country becomes an OECD member, in terms of India’s practice.

While coming to the above conclusions, the Hon’ble Supreme Court made the following observations:

• Upon India entering into a treaty or protocol does not result in its automatic enforceability in courts and tribunals; the provisions of such treaties and protocols do not therefore, confer rights upon parties, till such time, as appropriate notifications are issued, in terms of Section 90(1) of IT Act;
• In relation to India-France DTAA, the Protocol of 10 July 2000 did not extend the expanded definition, and instead confined the benefits to the definition and treatment of income from dividends, interest, and royalties. The “make available” condition, in other DTAAs, was consciously omitted from the notification. Such omissions indicate that a “trigger” event such as India granting favourable relief to a country per se does not cover all the benefits granted through the later instrument.
• The structure of the main DTAA, and its phraseology, based on negotiations with the countries concerned, i.e., Netherlands, France and Switzerland, also plays a role in the kind of benefits that are assured through it. The structure and terms of other DTAAs might be different; the coverage and definition of certain terms (FTS, permanent establishment, etc.) might be dissimilar. The revenue’s argument that granting automatic benefits based on the other country’s entry into the OECD is unfeasible, has merit.
• The status of treaties and conventions and the manner of their assimilation is radically different from what the Constitution of India mandates. In each of the said three countries, every DTAA entered into the executive government needs ratification. This means that after the intercession of the Parliamentary or legislative process/procedure, the DTAA is assimilated into the body of domestic law, enforceable in courts.
• In India, either the treaty concerned must be legislatively embodied in law, through a separate statute, or get assimilated through a legislative device, i.e., notification in the gazette; based upon some enacted law (some instances are the Extradition Act, 1962 and the Income Tax Act, 1961). Absent this step, treaties and protocols are per se unenforceable.
• Reliance was placed on the Vienna Convention on Law of Treaties (VCLT)⁶ and draft conclusions on Subsequent Agreements and Subsequent Practice in relation to the Interpretation of Treaties International Law Commission (ILC) for general rules of treaty interpretation.
• There is no dispute that treaties constitute binding obligations upon their signatories. Yet, like all compacts, how the parties to any specific instrument view them, gives effect to its provisions, and the manner of acceptance of such conventions or compacts are in the domain of bilateral relations and diplomacy.
• The issue of treaty interpretation and treaty integration into domestic law is driven by constitutional and political factors subjective to each signatory. Domestic courts cannot adopt the same approach to treaty interpretation in a black-letter manner, as is required or expected of them while construing enacted binding law.
• The treaty practice in India points to a consistent pattern of behaviour when the signatory to an existing DTAA, points to the event of a third state entering into OECD membership, and a resultant trigger event, the beneficial effect given to the later third-party state has to be notified in the earlier DTAA, as a consequential amendment, preceded by an exchange of communication (and perhaps, negotiation) and acceptance of that position by India. The essential requirement of a notification under Section 90 of the consequences of the trigger (or causative) event cannot be undermined.

BDO IN INDIA COMMENTS

This ruling would have a far-reaching impact across industries on all the past decisions wherein the benefit of the MFN clause has been taken considering that the third state was a member of the OECD at the time of applying the benefit. This will have an impact on all streams of income such as dividends, royalties, fees for technical services and interest to which the MFN clause is applicable – be it applying beneficial scope or beneficial tax rate. It may be noted that the Supreme Court’s decision is in line with the CBDT’s Circular of 2022 wherein one of the conditions for availing DTAA benefits under the MFN route was that the second country should have been notified. Currently, as India has not notified any country for the purpose of the MFN Clause, availing benefits under the MFN clause will be difficult. It may be pertinent to note that the Supreme Court has specifically excluded interpretation of the matter involving India-Spain DTAA and the said matter has been detagged. Thus, one needs to analyse the applicability of this decision to the MFN clause under India-Spain DTAA.

Additionally, this decision may have an impact on the Swiss Federation’s clarification on MFN under India-Switzerland DTAA⁷.