#TaxmannPPT | SC on Interpreting Application of Most Favoured Nation Clause in Tax Treaties

Hon’ble Supreme Court of India Interpreting the application of Most Favoured Nation Clause in context of India’s tax treaties Assessing Officer v. Nestle SA [2023] 155 taxmann.com 384 (SC) 25 October 2023

Most Favoured Nation Clause A snapshot

India has entered into a Double Taxation Avoidance Agreements (‘DTAA’) with several countries; Most Favoured Nation Clause (‘MFN’) included in protocol

Indian DTAAs [with MFN clause]

As per MFN, if India, in a separate DTAA with a third country (which is an OECD member), agrees for a lower or limited scope of taxation, that beneficial tax treatment will apply to India’s original treaty partner

Finland

MFN clause Story so far

Belgium

Snapshot of judgement

France

Practical Challenges

Hungary

Way forward

Netherlands

Scope of MFN • Restricting rate of tax and / or scope of taxing royalties, fees for technical services, dividend, interest • Restricting taxability of business profit (i.e., relaxing limitation on deductibility of executive and general administration) • Restricting taxability of profits from air transport and shipping operations • Favorable or effective arrangement of exchange of information

Spain Sweden Swiss Confederation United Kingdom Nepal Philippines Luxembourg Saudi Arabia

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Most Favoured Nation Clause Application of MFN vis-à-vis dividend income MFN clause

1989: India-Netherlands

Source state allowed to tax dividend at 10%

agreed for MFN

Story so far

Snapshot of judgement

2005: India entered DTAA with

Practical Challenges

Slovenia

2010: Slovenia became OECD member

Way forward

Source state allowed Slovenia became OECD member to tax dividend at 5% subsequently, MFN still applies?

2012: Netherlands issued a decree

Decree mentions that lower tax rate of 5% on dividend from India-Slovenia DTAA applies to India-Netherlands MFN

2020: Indian tax department defined MFN

(a) No separate notification and (b) Slovenia not OECD country at time of signing DTAA with India

2021: Hon’ble Delhi High Court granted relief to taxpayer

2022: CBDT issued MFN

2023: Supreme

circular

Court verdict

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Introduction to the judgement Story so far!

MFN clause

Vis-à-vis FTS income (Steria India)

AAR (2011)

High Court (2016)

[Favour of Revenue]

[Favour of taxpayer]

CBDT Circular no 3/2022 [February 2022] MFN clause and its application in context of Indian tax treaties

Vis-à-vis dividend income (Concentrix Services Netherlands BV, Optum Global Solutions International BV and Nestle SA)

• Third country which includes the lower tax rate / restricted scope, should be an OECD member country on the date of the signing of its tax treaty with India.

Income-tax authorities (2020/2021)

High Court (2021)

[Favour of Revenue]

[Favour of taxpayer]

• A notification under Section 90 of the Income-tax law is mandatory for Protocol / MFN to apply

Story so far

Snapshot of judgement Practical Challenges Way forward

• Unilateral decree/bulletin/publication do not represent understanding of the treaty partners on applicability of the MFN clause.

Question 1: Should the third country be OECD member country at the time of signing the tax treaty with India or at the time of applying MFN?

Question 2: Whether protocol (including MFN) applies automatically, or a separate notification is required?

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Snapshot of the judgement Principle laid down Held in favour of revenue department, as follows: Notification under Section 90(1) mandatory for a court, authority or tribunal to give effect to a DTAA / protocol (including MFN) which effects the provisions of Indian tax law

Separate notification, even when protocol notified along with DTAA?

India - Netherlands

India - France

Background Story so far

“…..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….

Snapshot of judgement Practical Challenges

Interpretation of expression “is”; third-party country to be an OECD member at the time of entering the DTAA with India. The fact that the third-party country becomes an OECD member subsequently does not automatically result in application of MFN

Way forward

India-Spain tax treaty to be analysed seperately

India - Swiss

India - Canada

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Practical challenges Vis-à-vis foreign taxpayers

Before Apex Court judgement

Post Apex Court judgement

•

MFN clause applied automatically

• MFN cannot be applied automatically unless notified

•

FTS income not offered to tax by taking shelter from the “make available” clause under MFN

• FTS / interest income on refund now taxable in India even though benefit of MFN available until MFN is notified

•

Dividend income offered at 5%

•

Interest on income-tax refund claimed exempt

•

No return of income filed in India where no tax payable in India pursuant to MFN

• • •

• • •

Vis-à-vis past: Order to apply retrospective or prospective?

Risk of re-opening past positions? Can this be a change in opinion?

Risk of re-opening past where assessment or reassessment is closed? Can this be a change in opinion?

Should claim be withdrawn in open assessments?

Penalty implications for past positions?

Provision required to be in books for past taxes?

Background Story so far

Snapshot of judgement

• Dividend income to be offered without taking benefit of MFN

Practical Challenges Way forward

• •

• • •

Vis-à-vis present and future: Advocacy measure?

Position to be adopted in return of income? i.e., offer income to tax without MFN benefit or wait for advocacy measure Alternate cash repatriation strategies from India?

File return of income absence MFN clause?

Will home country give credit of entire tax paid in India or limit as per the MFN clause?

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Practical challenges Vis-à-vis resident taxpayers Background

Before Apex Court judgement

Post Apex Court judgement

•

MFN clause applied automatically

• MFN cannot be applied automatically unless notified

Story so far

•

Tax withholding as per MFN clause; for example, dividend income taxed at 5%, FTS income not subject to tax withholding taking shelter of “make available” clause

• Indian resident payers to now withhold taxes without providing the benefit of MFN (until notified)

Snapshot of judgement

• •

• • •

Vis-à-vis past: Judgement to apply retrospective or prospective?

Risk of re-opening past positions - disallowance of expenses for non-tax withholding? Can this be a change in opinion?

Should claim be withdrawn in open assessments Penalty implications for past positions?

Provision required to be in books for past taxes?

Practical Challenges Way forward

Vis-à-vis present and future: • Advocacy measure?

• Should Indian payers begin withholding tax in the absence of MFN notification?

• Excess tax cost pursuant to withholding? Will it be borne by Indian payer or non-resident payee?

Impact on grossed up contracts?

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Way forward Next steps Background

“MNCs may face INR 11,000 cr retro tax demand on dividend income”

Story so far

Snapshot of judgement

“We were awaiting the Supreme Court order so there will be review of tax positions in many cases”

Practical Challenges Way forward

1. Financial impact of previous years position.

2. Position to be adopted for FY 2022-23 and going forward.

Jimit Devani +91 98207 51951 jdevani@deloitte.com

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