BackgroundSome of India’s tax treaties (including the treaties at issue in the case before the SC) contain MFN clause that extend the benefit of a concessional tax rate or restricted scope with respect to certain income (e.g., dividends, interest, royalties, fees for technical services, etc.) if, after that treaty is signed/entered into force, India concludes another tax treaty with an OECD member state that provides for a lower tax rate or restricted scope. For example, the MFN clause in the India-Netherlands tax treaty reads as follows:
The interpretation of the MFN clause and its application have been at the epicentre of litigation in India. With several High Court decisions in favour of the taxpayer, the Indian tax authorities decided to appeal to the SC, the highest judiciary authority in India. While the matter was pending before the SC, in 2022, the Central Board of Direct Taxes (CBDT)) issued a circular that laid down the conditions that must be satisfied to claim benefits under a MFN clause:
If after the signature of this convention under any Convention or Agreement between India and a third State which is a member of the OECD India should limit its taxation at source on dividends, interests, royalties, fees for technical services or payments for the use of equipment to a rate lower or a scope more restricted than the rate or scope provided for in this Convention on the said items of income, then as from the date on which the relevant Indian Convention or Agreement enters into force the same rate or scope as provided for in that Convention or Agreement on the said items of income shall also apply under this Convention. [emphasis added]
- The treaty with the third country must be concluded after the first treaty is signed/entered into force (depending on the wording of the MFN clause);
- The third country must be a member of the OECD at the time the treaty is signed;
- India limits its taxing rights with respect to relevant items of income in the treaty with the third country; and
- The Indian tax authorities issue a separate notification that imports the benefits of the treaty with the third country into the treaty at issue, as required by section 90(1) of the ITA.
Facts and issues before the SCThe cases before the SC involved the interpretation of the MFN clauses in India’s tax treaties with France, the Netherlands and Switzerland (there was also an issue with the India-Spain treaty, but the SC separated this case likely because there was no representation on this treaty before the court).
The taxpayer in the case involving the India-France tax treaty had applied the MFN clause to import a restricted definition of fees for technical services and the taxpayers in the cases involving India’s treaties with the Netherlands and Switzerland claimed the benefits of the MFN clause to import a concessional tax rate for dividends.
Thus, two questions were broadly before the SC:
- Whether a taxpayer has the right to invoke an MFN clause when the third country with which India has entered into a tax treaty was not an OECD member at the time the treaty was concluded but subsequently became an OECD member; and
- Whether an MFN clause is to be given effect automatically or whether it only comes into effect after a notification is issued by the Indian tax authorities?
SC decisionThe taxpayers and the tax authorities made vigorous arguments before the SC. Before pronouncing its verdict, the court referred to the Vienna Convention on the Law of Treaties, the writings of Klaus Vogel on the interpretation of tax treaties and decisions of the International Court of Justice. The SC overruled the 2021 decision of the Delhi High Court and held as follows:
- The beneﬁts in the later tax treaty do not automatically apply to the previously concluded treaty as the provisions do not confer rights on parties unless and until the appropriate notification that amends the terms of the earlier treaty is issued. Notiﬁcation under ITA section 90 is a necessary condition to give eﬀect to a tax treaty or protocol that has the eﬀect of amending existing provisions or law.
- An MFN clause will be triggered only if a third country is an OECD member at the time the treaty is signed.
- For a party to claim the benefit of the “same treatment” language in an MFN clause based on the entry into force of a tax treaty between India and another country that is an OECD member, the relevant date is the date the treaty was concluded if the treaty partner becomes an OECD member after entering into the treaty with India.
- Treaty practice in India points is consistent where the signatory to an existing tax treaty points to a third country becoming an OECD member, and a resultant trigger event, the beneficial effect given to the later third nation has to be notified in the earlier treaty, as an amendment, preceded by an exchange of communication and acceptance of that position by India.
BDO insightWith this decision, the SC indirectly upheld the validity of the conditions set out in the 2022 circular. Further, for India’s tax treaties that contain an MFN clause, the clause will not be relevant in the absence of a notification issued by the Indian tax authorities. Since India has not notiﬁed any country with respect to the MFN clause, availing beneﬁts under the clause will be challenging, with the result that nonresidents may be subject to higher rates of tax.
The SC decision will impact all taxpayers that have claimed benefits under an MFN clause, either in the form of concessional tax rates or where a restricted scope is adopted. It is possible that the Indian tax authorities may open past matters based on the SC decision and Indian companies may face demand notices from the tax authorities for shortfalls in tax withholding.
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