MFN benefit is not automatic: Indian Supreme Court Ruling on Interaction between Constitution, Domestic Law and Tax Treaties
Outline of the Article
The Indian Supreme Court delivered a landmark ruling which impacts multinational entities from countries such as France, Switzerland, and the Netherlands and earning income from India. The ruling would have a significant fiscal impact on the tax position adopted regarding the receipt of income such as royalties, fees for technical services or dividend income. It lays down the interaction between the Indian Constitution, the domestic tax law, and the double tax avoidance agreements regarding the assimilation of international treaties into national laws. The Indian Supreme Court held1 that the benefits under Most Favoured Nation clauses (“MFN clauses”) in the Double Tax Avoidance Agreement (“treaty” / “DTAA”) with India are triggered only upon issuance of a Notification from the Government of India extending such benefit. The ruling held that MFN benefit is not automatic even if the treaty's language does not mandate such Notification.
Setting the Context
India entered most of its existing bilateral tax treaties with its major trading partners (especially the developed OECD countries) in the 80s and 90s. India (a developing nation) is not a member of the OECD and has generally followed a sourced-based taxation approach based on the UN Model and not the OECD Model. For example - a payment towards fees for technical services from India to a foreign company would be taxable in India even without the recognition of a permanent establishment (PE) on a gross basis. India, a capital importer for the last several decades, also conceded the benefits in favour of other OECD nations through the Most Favoured Nation clause (“MFN clause”) under its tax treaties.
What is MFN?
MFN clauses provide for extending specified treaty benefits to the treaty partner based on a subsequent beneficial treaty provision adopted with a third country. In the Indian context, the benefits under the MFN clause are generally extended to member countries of the Organisation for Economic Co-operation and Development (“OECD”). For example, the MFN clause under the Protocol to the India-France treaty, which entered into force on 01.08.1994, reads:
“7. In respect of articles 11 (Dividends), 12 (Interest) and 13 (Royalties, fees for technical services and payments for the use of equipment), if under any Convention, Agreement or Protocol signed after 1-9-1989, between India and a third State which is a member of the OECD, India limits its taxation at source on dividends, interest, royalties, fees for technical services or payments for the use of equipment to a rate lower or a scope more restricted than the rate of scope provided for in this Convention on the said items of income, the same rate or scope as provided for in that Convention, Agreement or Protocol on the said items income shall also apply under this Convention, with effect from the date on which the present Convention or the relevant Indian Convention, Agreement or Protocol enters into force, whichever enters into force later.”
Fees for Technical Services (“FTS”) under the India-France are defined as “payments of any kind to any person, other than payments to an employee of the person making the payments and to any individual for independent personal services mentioned in Article 15, in consideration for services of a managerial, technical or consultancy nature”. This definition includes managerial services within its scope. The scope of the term is broader than the FTS definition, with a 'make available' clause present in India’s few treaties for example with the USA or the UK. By invoking the MFN clause, taxpayers from France were adopting a narrow definition of FTS from the India-Portugal/ India-UK treaty. The India-Portugal treaty had a ‘make available’ clause and excluded managerial services from the scope of the definition. Therefore, a French recipient of India-sourced income would seek to reduce its taxation in India, invoking the MFN clause.
MFN – Different Approaches
The conditions for applying MFN clauses are worded differently under different treaties entered into by India. For example, the India-Swiss treaty requires a bilateral re-negotiation between the treaty partners if a beneficial treatment on 'Fees for Technical Services' is extended to any other OECD member. The India-Finland treaty, on the other hand, requires the Indian Government to inform the competent authority of Finland that the conditions for the application of the MFN clause have been met and issue a notification for the application of the beneficial treatment.
The treaty language with France, the Netherlands, Spain, and Hungary mandates that the beneficial provisions in a treaty between India and a third OECD member country regarding specified articles shall also be available under the treaties with the said countries. There is neither a specific requirement to re-negotiate the treaty provisions nor to notify the application of beneficial treatment.
Genesis of the controversy that went to the Supreme Court
Case 1
The India-France treaty contains an MFN clause for importing the benefits extended to other OECD member countries. A French company was providing management services to its group entity in India. The Taxpayer (a French company) claimed that the fees for management services should not be taxable under the India-France treaty as FTS. The Taxpayer argued that FTS under the India-UK treaty, which is narrow in scope and beneficial to the Taxpayer, should be extended to the India-France treaty, applying the MFN clause. The definition of FTS under the India-UK DTAA does not include "managerial services". It also requires making available technical knowledge or skills to the payer.
Case 2
India entered into treaties with Slovenia, Lithuania, and Colombia, providing low rates for dividend and interest income. These countries acceded to membership of the OECD at a later stage after their treaties with India entered into force. The relevant dates (as example) are given below for reference:
| Name of the country | Date of Entry into Force of Treaty with India | Date of Notification of Treaty | Date of OECD membership |
| Slovenia | 17 February 2005 | 31 May 2005 | 21 July 2010 |
| Lithuania | 10 July 2012 | 25 July 2012 w.e.f. 1 April 2013 | 5 July 2018 |
| Colombia | 7 July 07 2014 | 23 September 2014 | 28 April 2020 |
These treaties had a beneficial rate of tax on dividend income from India. The companies from the Netherlands and Switzerland sought to apply the MFN clause and used the lower rates provided for under, for example, the treaty with-Slovenia, which later became an OECD member. These taxpayers contended that for applying the MFN clause, the requirement of the third country with a beneficial treaty rate being a member of OECD should be examined at the time of applying the treaty benefits and not at the time when the treaty between India and such third countries entered into force. The French, Dutch and Swiss authorities, under their respective domestic laws, had issued unilateral decrees and orders extending the beneficial rates from treaties with Slovenia and Lithuania under their respective treaty with India.2
Favourable High Court rulings and Tax Office Circular
The High Court (a constitutional court)3 ruled in favour of the taxpayers and allowed the MFN benefit. The Court rejected the plea of the tax department that a separate notification was required for extending the benefits arising from the MFN clause.
After this judgment, the Indian Tax Office issued a Circular4 covering the fact pattern of Case 2. The Circular clarified that the benefit from the treaties with Slovenia, Lithuania and Colombia could not be imported using the MFN clause. One of the reasons specified was that India had not issued a Notification importing benefits under the treaties described above into other treaties with MFN clauses. The Government challenged the judgments from the Delhi High Court before the Supreme Court of India.
The Supreme Court ruling
The Supreme Court ruled in favour of the tax office. It held that provisions of treaties and protocols do not confer rights upon parties until the Government issues appropriate notifications as per the domestic legal framework in India. In other words, the treaties entered by the 'executive' wing of the Government must be ratified by the 'legislative' wing by legislation or Notification.
While analysing the treaty practice of India, the Court gave the example of specific notifications issued in the case of the India-Netherlands and India-France treaties, wherein the beneficial provisions from India-Germany, India-USA and a few other treaties with OECD members were explicitly notified.
The Court referred to Article 31(3) of the Vienna Convention on Law of treaties5 and observed that whilst considering treaty interpretation, it is vital to consider the subsequent practices of the parties to confirm its intention. The Court noted that the practice of India to issue a notifications for enforcing benefits under the MFN clause is a 'practice'. The Supreme Court sided with the tax department on a nuanced issue that the ‘make available’ clause will not be available under the India-France treaty since it has not been expressly provided in the Notification issued by the Government.
The Court rejected the reliance placed by the taxpayers on unilateral decrees/decisions issued by the Dutch, French and Swiss Tax authorities on the principle of reciprocity. The Court reasoned that the decree/decisions were issued pursuant to respective municipal law requirements in those countries. The Court examined the legal process for enacting a treaty in Switzerland, France, and the Netherlands. It opined that the status of treaties and the manner of their assimilation into the national law is radically different from what the Constitution of India mandates.
The other question before the Supreme Court was whether the beneficial provisions from India’s treaties with Slovenia and Lithuania could be relied on for MFN treaty benefits even though they became OECD members subsequent to the conclusion of their treaties with India. The Supreme Court interpreted the language of the MFN clause to hold that a third country shall be an OECD member when entering a treaty with India. The membership of the OECD on the date of applying for the benefit of the MFN clause is not sufficient. The Court accepted the argument of the tax department that the Indian Government could not have contemplated the subsequent OECD membership of Slovenia, Lithuania, and Colombia at the time of entering into treaties with them.
The benefit from the treaties with Slovenia, Lithuania and Colombia was, therefore, denied to the taxpayers under the India-Netherlands, India-France, and India-Switzerland treaties for non-fulfilment of conditions under the MFN clause.
Indian Tax Treaties Impacted
The immediate effect of the Supreme Court could be explained by referring to the example of the India-France treaty. India has notified the benefits by virtue of the MFN clause in the case of the treaty with France. Such Notification does not extend the application of a narrow definition of FTS with a 'make available' clause. French residents consequently would not be eligible for the narrow definition of FTS and are, hence, liable to tax in India. In fact, the tax authorities in India might recover taxes on payments not considered as FTS relying on the 'make available' clause. Similar treatment holds true for the India-Belgium treaty as well.
Dutch, French and Swiss residents (and for that matter any OECD country resident where MFN clause exist) would not be eligible for a lower rate of withholding tax on dividend and interest available under the treaties with Slovenia, Lithuania, and Colombia. Tax benefits availed by invoking MFN clauses might now be payable to the Indian tax authorities.
The resultant benefits under the majority of the Indian treaties with MFN clauses are not notified by the Government. The treaty practice would be to make a conscious choice and allow the benefit in every case where the MFN clause exists.
As a significant impact on taxpayers from Switzerland, Spain, Sweden and Hungary, the benefit of the MFN clause would not be available until the Government of India notifies the beneficial applications under MFN clauses in these countries.
Legal Effects of the Decision
The judgment of the Supreme Court is the law of the land. It is deemed to be the correct interpretation from the time the underlying legal provisions came into effect. Therefore, the immediate effects of the Supreme Court judgments are:
a. All pending litigation and claims before the tax authorities and courts regarding the applicability of MFN clauses would be decided in accordance with the Supreme Court judgment.
b. Past claims of treaty benefits invoking the MFN clause could be re-examined by the tax authorities to deny the benefit and recover the due taxes with interest. Under the re-assessment provisions, the look-back period could range from 3 to 10 years.
c. The Indian payers would be subject to additional WHT liability where MFN benefit was claimed, along with interest and penalty. But penalties could be defensible since the judicial interpretation prior to this Supreme Court judgment favoured the taxpayers.
d. Where taxes are paid in India without applying the MFN clause following this ruling, the other treaty partner may deny credit for taxes paid on the ground that the taxes paid in India are not in line with its interpretation of the treaty provisions. This could lead to double taxation.
Way forward
The judgment of the Supreme Court of India has toned down the application of the MFN clause, where the Indian Government has specifically notified the resultant benefit from the MFN clause. Since the judgment of the Supreme Court binds the Taxpayer and the tax department, transactions by residents of jurisdictions having an MFN clause in their treaties with India must be thoroughly examined for eligibility to claim such benefits.
India follows a “dualist” practice for treaty implementation, implying that after ratification of a treaty entered by India, the provisions need to be incorporated into the municipal laws, to be enforceable. The Supreme Court has approved this practice to apply even for resultant benefits from a clause in the already notified treaty or Protocol. Unless the tax treatment afforded to OECD members is aligned, of course subject to individual treaty stipulations, the sovereign commitment by way of MFN clauses in treaties would be meaningless. It now remains with the Government to bring MFN clauses to life wherever they exist.
Footnotes
1 Assessing Officer v. M/s Nestle SA Civil Appeal No. 1423/2023 accessible at https://main.sci.gov.in/supremecourt/2022/6394/6394_2022_8_1502_47832_Judgement_19-Oct-2023.pdf.
2 Netherlands Decree: Decree No. IFZ 2012/54M dated 28.02.2012 issued by Directorate General for Tax Affairs, Kingdom of Netherlands; French order dated 04.11.2016 - https://bofip.impots.gouv.fr/bofip/1188-PGP.html/identifiant%3DBOI-INT-CVB-IND-20161104; Swiss order issued in 2021 - https://www.estv.admin.ch/dam/estv/fr/dokumente/intsteuerrecht/themen/auslaendische-quellensteuern-pro-land/i/indien-fachmitteilung-mfn.pdf.download.pdf/indien-fachmitteilung-mfn.pdf.
3 Delhi High Court - Concentrix Services Netherlands BV v. ITO (2021) 434 ITR 516 (Delhi); Steria (India) Ltd. v. CIT (2016) 386 ITR 390 (Delhi).
4 Circular No. 3/2022 dated February 03, 2022. Circulars reflect the interpretation of the Indian tax authorities. They are not considered binding on a court or the taxpayers to the extent prejudicial to them.
5 Also referred to the International Law Commission (ILC)’s Draft Conclusions on Subsequent Agreements and Subsequent Practice in relation to the Interpretation of Treaties (“ILC Draft Conclusions”)
