Explained: Recent Supreme Court judgement on applicability of Most Favoured Nation (MFN) for Taxation

Question: We are an Indian-based entity with various group companies in foreign jurisdictions. There are many intercompany transactions with such group companies which are subjected to a lower withholding tax rate in accordance with the relevant treaty owing to MFN. Kindly highlight the recent Supreme Court judgement in the case of applicability of the Most Favoured Nation MFN.

Answer by Dr Suresh Surana, Founder, RSMIndia: The Apex Court (while hearing batch of appeals arising from decisions of the Delhi High Court in the case of CIVIL APPEAL NO(S). 1420 OF 2023 Assessing officer Circle International Taxation) 2(2)(2) New Delhi vs M/s Nestle SA) passed a vital judgement involving interpretation of the Most Favoured Nation (MFN) clause contained in various Indian treaties with countries that are members of the Organisation for Economic Cooperation and Development (hereafter ‘OECD’).

Issue 1:

Whether there is any right to invoke the MFN clause when the third country with which India has entered into a Double Tax Avoidance Agreement (hereafter ‘DTAA’) was not an OECD member yet (at the time of entering into such DTAA)

The Supreme Court concluded that a taxpayer/party in order to claim benefit of a MFN clause, based on entry of DTAA between India and another state which is member of OECD, the relevant date is entering into treaty with India, and not a later date, when, after entering into DTAA with India, such country becomes an OECD member, in terms of India’s practice.

Issue 2:

Whether the MFN clause is to be given effect to automatically or if it is to only come into effect after a notification is issued.

The Apex Court held that a notification under Section 90(1) is necessary and a mandatory condition for a court, authority, or tribunal to give effect to a DTAA, or any protocol changing its terms or conditions, which has the effect of altering the existing provisions of law.

The fact that a stipulation in a DTAA or a Protocol with one nation requires the same treatment with respect to a matter covered by its terms, subsequent to its being entered into when another nation (which is member of a multilateral organization such as OECD), is given better treatment, does not automatically lead to integration of such term extending the same benefit in regard to a matter covered in the DTAA of the first nation, which entered into DTAA with India. In such event, the terms of the earlier DTAA require to be amended through a separate notification under Section 90.

The above 2 important issues with respect to DTAAs, on which jurisprudence has been laid down by the SC in its recent judgement needs to be factored in case of any cross-border transactions and related payments.

Also Read: Form 10F filing online: Is Permanent Account Number (PAN) mandatory for NRIs?

This verdict will have relevance in many cases wherein Indian corporates have made payments either towards dividends, royalty, Fees for technical services for interest and where the benefit of the MFN clause has been provided by them, while making payments outside India

For instance, this SC judgement would directly be applicable in the case of dividend remittances made by Indian companies with foreign shareholding and where the benefit of lower withholding tax rate of 5% was taken after factoring the MFN clause. To illustrate, say the foreign shareholder holding more than 10% shares of the Indian Company, is a tax resident of Netherlands and is in receipt of dividend from such Indian Company. In this specific case, as per Article 10 on Dividends of the India Netherlands tax treaty, the tax rate specified under the tax treaty is 10%, subject to the other conditions like provision of TRC, etc. Further, the protocol to the India-Netherlands treaty was signed on 10th May 2012, which contains a clause as under:

“2. 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.”

Also Read:Angel Tax implications for a new company intending to raise capital by issuing shares – Explained

Notably, India entered into a DTAA with Slovenia, when it was a non-OECD member and the rate of tax on dividends as per the treaty was 5%, where the shareholding in the Indian company is more than 10% and in other cases, 15%. Slovenia became an OECD member later in 2018. The SC observed that countries like Slovenia, Lithuania & Columbia, were initially not members of OECD when they entered into treaties and protocols with India and that they became members later. The SC ruled that, when a third-party country enters into DTAA with India, it should be a member of OECD, for the earlier treaty beneficiary to claim parity. Further, the SC held that a notification under Section 90(1) is necessary and a mandatory condition for a court, authority, or tribunal to give effect to a DTAA, or any protocol changing its terms or conditions, which has the effect of altering the existing provisions of law.

As such, pursuant to this SC judgement, the rate of 10% as per the India-Netherlands treaty should be applicable on dividends paid (to a foreign company in Netherlands holding more than 10% shares of Indian Co) rather than 5% as per the India-Slovenia tax treaty and the benefit of MFN shall not be available.

The SC judgement would have far-reaching consequences for multinational corporations from all countries with whom India has an MFN clause as discussed above and who have taken advantage of it for dividend, interest, royalties, and FTS payments. Also, it will be interesting to observe how the tax authorities will use this Supreme Court decision to reopen the various concluded assessments.

This Q&A series is published every week on Thursday.

Disclaimer: The views and facts shared above are those of the expert. They do not reflect the views of financialexpress.com