Indian Supreme Court Ruling on MFN Clause

03/11/23

The Indian Supreme Court ruled that a taxpayer can only avail the benefits of the Most Favored Nations clause after the Indian government issues a notification. In addition, the Court ruled that for a party to claim benefit of ‘same treatment’ through the MFN clause (in the case at hand: the lower beneficial rate of 5%), the date of relevance is the one at which time the other country entered into the treaty with India, and not a later date (when, after entering into the treaty with India such country became an OECD member). This means that when a country enters into the treaty with India, it should be a member of OECD for the beneficiary to claim parity under the earlier treaty which contains a MFN clause.

What does it mean for you?

In case that you have claimed a more beneficial rate for dividends, interest, royalties or fees for technical services based on the MFN clause included in the Netherlands - India double tax treaty, this decision of the Indian Supreme Court may affect your position as an additional amount of tax may be assessed by the Indian tax authorities. In mainstream Indian media it is reported that the Indian government is looking to recover tax of circa EUR 1.25Bn from various Multinational Companies that have taken benefit of MFN clauses in their tax positions in the past.

Facts

India has concluded tax treaties with the Netherlands, France, and Switzerland (the FNS countries). Subsequently, it also entered into a protocol/Most Favored Nations (MFN) clause with the respective FNS countries laying down that, if India provides a more favorable rate or a scope more restricted to any other OECD member, such favourable rate or restricted scope be also provided to the respective FNS countries from the date on which such subsequent relevant double tax treaty enters into force.

India entered into a tax treaty with Slovenia, Lithuania and Colombia (the SLC countries) that provide for a lower beneficial rate of 5% on dividends. At the time of providing such a beneficial rate, those countries were not members of the OECD.

The taxpayer in this case sought to invoke a lower beneficial rate of 5% on dividend income under the MFN clause in the treaties with the FNS countries, vis-à-vis the treaties with the SLC countries, which became OECD members subsequent to entering into treaties with India. The said requests were rejected by the tax authorities, a decision that was later challenged before the Delhi High Court in various instances. The Delhi High Court subsequently ruled in favour of the taxpayers.

In light of the above, the decisions of the Delhi High Court involving the interpretation of the MFN clause contained in various Indian tax treaties with OECD countries went before the Supreme Court of India in the batch of appeals. The bilateral treaties in question are between India and the respective FNS countries.

The issue in the case at hand

The case in question revolves around the application of the MFN clause in a treaty that India has concluded with an OECD member country. Specifically, the issue is whether the MFN clause can be invoked in the context of another treaty that India has with an OECD member country, which at the time of the treaty’s conclusion, was not an OECD member.

Furthermore, the case raises the question of whether the MFN clause should be automatically effective, or if it should only come into effect following the issuance of a notification under Section 90 of the Income Tax Act 1961.

Indian Supreme Court’s judgment

According to the Supreme Court and as per the judicial precedents, India entering into a tax treaty or protocol does not result in such treaty or protocol’s automatic enforceability in courts and tribunals. The provisions of such treaties and protocols do not, therefore, confer rights upon parties until appropriate notifications are issued in terms of section 90 of the Act. As a result, a taxpayer could avail itself of the benefit of the MFN clauses under India’s income tax treaties with the FSN countries, only after the Indian government issued a notification under Section 90 of the Income Tax Act 1961, to that effect. According to Indian practice, such a notification gives effect of the subsequent event of a more beneficial arrangement with a third country, to the country which had entered into a tax treaty previously, on the basis of a treaty provision.

In addition, the Supreme Court ruled that for a party to claim benefit of ‘same treatment’ through the MFN clause (in the case at hand: the lower beneficial rate of 5%), the date of relevance is the one at which time the other country entered into the treaty with India, and not a later date, when, after entering into the treaty with India such country becomes an OECD member. This means that when a country enters into the treaty with India, it should be a member of OECD for the beneficiary to claim parity under the earlier treaty with a MFN clause. More information can be found here.

Please contact your PwC tax advisor for more information about the implication of this judgment to your tax position also considering that the Indian government is looking to recover tax of circa EUR 1.25Bn from various Multinational Companies that have taken benefit of MFN clauses in their tax positions in the past.