SC: There is no automatic application of MFN clause for lower withholding tax in India
Mumbai, Oct 19, 2023
In a big win for the revenue authorities, the Supreme Court of India (SC) has held that the provisions of the ‘Most Favoured Nation’ (MFN) clause in a tax treaty are not triggered automatically and a separate notification is required. The SC’s order is likely to result in re-opening of several high-value cases, and government officials estimate that the tax demands that follow could run into several thousand crores.
The SC was hearing a batch of appeals arising from decisions of the Delhi high court involving interpretation of the MFN clause contained in various Indian treaties with countries that are members of the Organisation for Economic Cooperation and Development (Oecd).
The fallout of the order will be widespread. For example, the Netherlands is a popular jurisdiction in tax structuring. Netherland entities that had relied on the MFN clause, resulting in lower withholding of tax in India against their dividend income, will be adversely impacted, as will the Indian subsidiaries that paid the dividend at a lower rate. Tax demands that will now be raised will also include interest and penalties.
Tax treaties and protocols entered into by India, with several Oecd-member countries such as Netherlands, France, Switzerland, Spain, Hungary, to name a few, contain a MFN clause. This clause provides for a lower rate of withholding tax on dividend, interest, royalties or fees for technical services (FTS), if a lower rate is prescribed in a tax treaty that India enters into subsequently with another Oecd-member country. Similarly, the benefit of a narrow definition of royalty or FTS, in a subsequent tax treaty, can be adopted.
Abhishek Goenka, partner, Aeka Advisors, said, “The apex court’s order turns on its head the widely accepted view that any subsequent tax treaty signed with an Oecd-member country, irrespective of when that country became a member, will automatically be read into all existing treaties with Oecd-members. Going forward, the benefit of the MFN clause can be involved only after the Government of India issues a notification and makes the relevant modification in the relevant (earlier) tax treaty.”
The SC set aside the Delhi high court’s order issued on April 22, 2021, in the case of Concentrix Services Netherlands BV and others. Under the India-Netherlands tax treaty, the withholding rate in India for dividend income was 10%. The Delhi high court had held that as India had agreed on a 5% withholding tax rate in its subsequent tax treaties (with Slovenia, Lithuania, and Colombia), thus the lower rate of 5% should equally apply to the India-Netherlands Tax Treaty. This order was followed by the high court taking a similar view in case of Nestle. Similarly, in the case of Steria India, the high court had upheld that the more restrictive definition of ‘Fees for Technical Services’ in the India-UK tax treaty must also apply to the India-France Treaty.
The crux of the high court’s order was that the MFN clause is an integral part of the tax treaty and is triggered automatically, without the need for a separate notification. However, in their order issued on Thursday, the SC bench composed of Justice S Ravindra Bhat and Justice Dipankar Datta said, “A notification under Section 90(1) of the Income-tax (I-T) Act, is necessary and a mandatory condition for a court, authority, or tribunal to give effect to a tax treaty, or any protocol changing its terms or conditions, which has the effect of altering the existing provisions of law.”
Girish Vanvari, founder, Transaction Square, said, “The Central Board of Direct Taxes had issued a circular stating that without a notification, the MFN clause cannot be automatically incorporated. Courts had ruled against such a requirement. The SC has now held that invocation of MFN clauses in India’s treaties with Netherlands, France and Switzerland will require a specific notification. This will have very wide ramifications for MNCs, from all countries with whom India has a MFN clause and who have taken the benefit of this clause for their dividend, interest, royalty and FTS income.”
Goenka illustrates: The tax treaty between India and Canada provides a restrictive scope for taxing payments in the nature of FTS. An entity covered by the India-France treaty could invoke this restricted definition whereby there would be no obligation on the Indian payer to withhold tax in India. Going forward, this position will no longer be tenable, until the notification is issued.
The second issue dealt with by the Supreme Court was whether Slovenia, Lithuania and Colombia, needed to be members of the Oecd at the time of signing of their tax treaty with India, for the MFN clause to apply. These countries had became members of the Oecd after India signed treaties with them. For eg: the tax treaty between India and Solvenia was executed in February 2005 and this country became an Oecd member in July 2010. In this context, the SC bench observed that these countries needed to be Oecd members at the time the tax treaty with India was signed.
[The Times of India]
