Sidhant Singh
Introduction
The Supreme Court (SC) of India has recently delivered a landmark judgment interpreting the Most Favoured Nation (MFN) clause in Double Taxation Avoidance Agreements (DTAAs). In this case (Assessing Officer Circle (International Taxation) 2(2)(2) New Delhi vs. Nestle SA) the matter was related to the determination of the applicable date for invoking the MFN clause in the DTAA. The deliberate focus was on whether the relevant date should be the signing date of the treaty, or a subsequent date when the respective country becomes an Organisation for Economic Co-operation and Development (OECD) member. The court held that the relevant date to invoke the MFN clause is the date when the treaty was made, not when a country joined the OECD later on. This judgement has aroused anxiety among stakeholders about the possible consequences of the ruling for international trade. Some are concerned about the issue of whether such a controversial measure could hurt global economic relations, especially with contributory factors like retrospective tax claims, interest accruals, and possible disruptions in business cash flows. The verdict has raised important questions regarding the reliability and consistency of tax regimes as the two are the most important factors of international trade and investment.
Such concern is highlighted in The Economic Times report, which stated that about 11,000 crores of tax could be imposed on multinational companies operating in India as a retrospective measure. Furthermore, Foreign Portfolio Investors from the Netherlands will now be liable for a 10% withholding tax, an increment of 5% that may lead to a decline in their return on investment from India. Besides this, there is a fear of the income tax authorities reopening cases even from the past assessment years which would, in turn, add more confusion as to when the computation of income tax would be completed. As the object of DTAA is to mitigate the impact of double taxation on a taxpayer who engages in cross-border economic activities, this ruling potentially increases tax liabilities for MNCs and foreign investors operating in India, there is a worry that these companies may face double taxation. Hence, the question arises, would other contracting states provide any tax credits to the investors to mitigate the impact of double taxation that may arise?
Background of Disputes over Most Favored Nation Treatment
A DTAA is an agreement between different countries aimed at preventing people or businesses from being taxed twice on the same income, thus avoiding double taxation. If countries want to make sure all their DTAA agreements offer similar benefits, they can include an MFN clause. The MFN clause ensures equitable tax treatment among treaty partners, preventing double taxation and fostering fair economic relations. When a country (let’s call it Country A) enters into a tax treaty with another country (Country B), the MFN clause ensures that if Country A subsequently negotiates a more favourable tax provision with a third country (Country C), then Country A is obligated to extend those more favourable provisions to Country B through the MFN clause. India had entered into DTAA with different OECD member nations (like Netherlands, France, and Switzerland) that included MFN clauses, granting these countries MFN status, here’s where OECD membership comes into play, the recent SC judgment clarified that the MFN clause shall be triggered only when the third country is a member of the OECD at the time of entering into DTAA with India. Let’s delve into the background of disputes over MFN.In 1989, India and the Netherlands signed a DTAA, which was later amended in 2012 to include an MFN Clause. Following this, in 2013 India also entered into a DTAA with Lithuania, despite Lithuania being not a member of the OECD at that time and attained membership of OECD in 2018.
In the India-Netherlands agreement, the MFN Clause prescribes that any preferential tax treatment India provides to some other country under a DTAA must also be extended to the Netherlands’ residents. As a result, when India signed the DTAA with Lithuania, the Netherlands residents also became entitled to the same tax treatment as Lithuanian residents. While India has extended the same kind of DTAA and MFN Treatment to other countries, however, disputes have arisen over the effective date from which the residents of these countries can claim the benefits of MFN treatmentand the question of whether a notification is necessary from India to amend the India-Netherlands DTAA to include new provisions. These disputes gave rise to a spate of petitions that were filed before the SC to resolve the issue.
Consider this scenario: In a team of three members, Member A gets a salary of Rs. 100 with the understanding that if any other member is given a higher salary or better terms, the same treatment will be extended to Member A. The question arises: Would Member A automatically receive the improved terms or would he have to wait till the employer issues the notification to implement the new terms?
This was an issue that was considered by the Hon’ble Supreme Court in the batch of matters surrounding the interpretation of the term “notification.” A further matter of significance dealt with by the Hon’ble Supreme Court here was whether one has a right to claim MFN status regarding any of the provisions of a third country with whom India has entered into a DTAA, even if that third country was not a member of the OECD at the time of entering into such DTAA.
Before the extensive hearings of batch petitions by the Hon’ble Supreme Court, the Hon’ble Delhi High Court (HC) specified some principles in cases like Steria (India) Ltd. v. CIT [2016] and Concentrix Services Netherlands B.V. v. ITO (TDS) [2021] and stated that the MFN mechanism, which is the essence of the DTAA, is automatically applicable once the DTAA is notified. Hence, there is no need for a separate notice. Moreover, the MFN clause becomes effective automatically once the third party becomes a member of the OECD after a DTAA agreement containing the MFN clause is signed with a second country.
Interpretation by the Supreme Court
The Supreme Court in the verdict disagreed with the Delhi High Court, which had liberally interpreted the word ‘is’ from the phrase ‘which is a member of OECD’ (mentioned in the Protocol) allowing the benefit of the MFN clause to countries who attained OECD membership after the DTAA was entered into. However, the Apex Court ruled that the term “is” refers to the present status at the time of entering into the DTAA. Thus, a country must be a member of the OECD at the time of entering into the DTAA agreement to claim benefits under the MFN clause. In addition, the Court clarified that the more restrictive scope provided in a treaty with a third country will only apply if that third country is a member of the OECD at the time when the second country concluded its treaty with India. This means that the MFN clause would not be triggered unless the third-party country is an OECD member when the second country signs its treaty with India.
The Supreme Court held that for the MFN clause to be automatically triggered, it is essential to give effect to the DTAA through a notification under Section 90 of the Income Tax Act, 1961. The Court pointed out that unlike in some other countries, where signing or ratifying a treaty automatically makes it enforceable, this is not the case in India. It is so because the Parliament is exclusively vested with the power to legislate such a treaty, as per Article 253 of the Constitution of India. The Court referred to the case of State of Gujarat v. Vora Fiddali Badruddin Mithibarwala, noting that the Parliament has the exclusive authority to decide whether to implement or not to implement the treaties. Consequently, being a signatory to a treaty or protocol does not affect the enforceability of such a treaty or protocol in the Indian courts. In order to be entitled to these rights, a notification must be rendered under Section 90(1) of the Income Tax Act, 1961.
Conclusion
The Honourable Court with this ruling has made a huge leap and changed the way Tax Treaties are understood by the lower courts and has not only departed from the former view but has changed the way they are interpreted and understood. The Supreme Court’s decision for notification of an MFN clause in a way introduces a new level of uncertainty. It suggests that the MFN clause would never be separately notified or notified in part, or at a later point in time. This departure from the established trite principle of law that ‘a bilateral agreement cannot be altered unilaterally by one party’ raises concerns about the reliability of internationally recognized beneficial provisions, which are now subject to sovereign notification.
The judgement has a retrospective application hence it opens up the possibility for taxpayers to revisit past tax differentials and interest levied based on the MFN clause. If a more favourable provision exists in another treaty, taxpayers can seek its application retrospectively. This ruling provides a mechanism to address historical tax disparities. While the Hon’ble Court has made it clear that the authority of the Parliament is undisputable, it has ironically overlooked the financial impact on developing countries that rely on importing capital and need to support capital exporters. . The Supreme Court has not taken into account the fact that this decision will likely lead to higher taxation rates for international investors. Swiss, French, and Dutch companies, which are already active in India will have to re-evaluate their tax repatriation and return on investment analysis formulas as they will have to face higher taxes now.
The judgement presents a complex and contentious scenario and it is yet to be seen how the Central Board of Direct Taxes would manage the repercussions through the post-judgment notifications.
This article is authored by Sidhant Singh, a second-year student at Hidayatullah National Law University, Raipur.
Society for International Trade & Competition Law 
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